UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC  20549




FORM
10-K




(Mark
One)


x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
fiscal year ended December 31, 2009




OR




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
transition period from 
to




Commission
File No.  0-18279




TRI-COUNTY FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)




Maryland
              
              52-1652138(State
      or other jurisdiction of
              
              (I.R.S.
      Employerincorporation
      or organization)
              
              Identification
      No.)





3035 Leonardtown Road, Waldorf,
      Maryland
              
              20601(Address
      of principal executive offices)
              
              (Zip
      Code)




Registrant’s
telephone number, including area code:  (301)
645-5601




Securities
registered pursuant to Section 12(b) of the Act:  None




Securities
registered pursuant to Section 12(g) of the Act:




Common Stock, par value
$0.01 per share


(Title of
Class)




Indicate
by check mark whether the registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act.  Yes  ̈  No
x





Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.  Yes ̈Nox





Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and
(2) has been subject to such filing requirements for the past 90
days.  YesxNo ̈




Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such
files).  Yes ̈No ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  x




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):




Large
      accelerated filer   ̈
              Accelerated
      filer   ̈Non-accelerated
      filer   ̈
              Smaller reporting
      companyx(Do
      not check if a smaller reporting company)




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.)  Yes  ̈ No
x





The
aggregate market value of voting stock held by non-affiliates of the registrant
was approximately $27.9 million based on the closing price ($12.01 per share) at
which the common stock was sold on the last business day of the Company’s most
recently completed second fiscal quarter.  For purposes of this
calculation only, the shares held by directors and executive officers of the
registrant are deemed to be shares held by affiliates.




Number of
shares of common stock outstanding as of March 5, 2010: 2,994,207




DOCUMENTS
INCORPORATED BY REFERENCE




1.         Portions
of the Annual Report to Stockholders for the year ended December 31,
2009.  (Part II)


2.         Portions
of the Proxy Statement for the 2010 Annual Meeting of
Stockholders.  (Part III)








INDEX





PagePart
      IItem
      1.
                                Business
                                
                                
                                1Item
      1A.
                                Risk
      Factors
                                
                                
                                24Item
      1B.
                                Unresolved
      Staff Comments
                                
                                
                                30Item
      2.
                                Properties
                                
                                
                                30Item
      3.
                                Legal
      Proceedings
                                
                                
                                30Item
      4.
                                [Reserved]
                                
                                
                                30Part
      IIItem
      5.
                                Market
      for Registrant’s Common Equity, Related Stockholder Matters
      and Issuer Purchases of Equity
Securities
                                
                                
                                31Item
      6.
                                Selected
      Financial Data
                                
                                
                                31Item
      7.
                                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
                                
                                
                                32Item
      7A.
                                Quantitative
      and Qualitative Disclosures about Market Risk
                                
                                
                                32Item
      8.
                                Financial
      Statements and Supplementary Data
                                
                                
                                32Item
      9.
                                Changes
      In and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                
                                
                                32Item
      9A(T)
                                Controls
      and Procedures
                                
                                
                                32Item
      9B.
                                Other
      Information
                                
                                
                                33Part
      IIIItem
      10.
                                Directors,
      Executive Officers and Corporate Governance
                                
                                
                                33Item
      11.
                                Executive
      Compensation
                                
                                
                                33Item
      12.
                                Security
      Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters
                                
                                
                                34Item
      13.
                                Certain
      Relationships and Related Transactions and Director
      Independence
                                
                                
                                34Item
      14.
                                Principal
      Accountant Fees and Services
                                
                                
                                35Part
      IVItem
      15.
                                Exhibits
      and Financial Statement Schedules
                                
                                
                                35


i


PART
I




This report contains certain
“forward-looking statements” within the meaning of the federal securities
laws.  These statements are not historical facts, rather statements
based on Tri-County Financial Corporation’s current expectations regarding its
business strategies, intended results and future
performance.  Forward-looking statements are preceded by terms such as
“expects,” “believes,” “anticipates,” “intends” and similar
expressions.





Management’s ability to predict results
or the effect of future plans or strategies is inherently
uncertain.  Factors that  could affect actual results
include interest rate trends, the general economic climate in the market area in
which Tri-County Financial Corporation operates, as well as nationwide,
Tri-County Financial Corporation’s ability to control costs and expenses,
competitive products and pricing, loan delinquency rates and changes in federal
and state legislation and regulation.  These factors should be
considered in evaluating the forward-looking statements and undue reliance
should not be placed on such statements.  Tri-County Financial
Corporation assumes no obligation to update any forward-looking statement after
the date of the statements or to reflect the occurrence of anticipated or
unanticipated events.





Item
1.  Business





Tri-County
Financial Corporation (the “Company”) is a bank holding company organized in
1989 under the laws of the State of Maryland.  It owns all the
outstanding shares of capital stock of Community Bank of Tri-County (the
“Bank”), a Maryland-chartered commercial bank.  The Bank was
originally organized in 1950 as Tri-County Building and Loan Association of
Waldorf, a mutual savings and loan association, and in 1986 converted to a
federal stock savings bank and adopted the name Tri-County Federal Savings
Bank.  In 1997, the Bank converted to a Maryland-chartered commercial
bank and adopted its current name.  The Company engages in no
significant activity other than holding the stock of the Bank and operating the
business of the Bank.  Accordingly, the information set forth in this
report, including financial statements and related data, relates primarily to
the Bank and its subsidiaries.





The Bank
serves the Southern Maryland counties of Charles, Calvert and St. Mary’s, (the
“Tri-County area”) through its main office and nine branches located in Waldorf,
Bryans Road, Dunkirk, Leonardtown, La Plata, Lusby, Charlotte Hall, Prince
Frederick and Lexington Park, Maryland. The Bank operates fifteen automated
teller machines (“ATMs”) including five stand-alone locations in the Tri-County
area. The Bank offers telephone and internet banking services. The Bank is
engaged in the commercial and retail banking business as authorized by the
banking statutes of the State of Maryland and applicable federal regulations,
including the acceptance of deposits, and the origination of loans to
individuals, associations, partnerships and corporations. The Bank’s real estate
financing consists of residential first and second mortgage loans, home equity
lines of credit and commercial mortgage loans. Commercial lending consists of
both secured and unsecured loans.  The Bank is a member of the Federal
Reserve and Federal Home Loan Bank (the “FHLB”) system and its deposits are
insured up to applicable limits by the Deposit Insurance Fund administered by
the Federal Deposit Insurance Corporation (the “FDIC”).





The
Company’s executive offices are located at 3035 Leonardtown Road, Waldorf,
Maryland. Its telephone number is (301) 645-5601.





Available
Information





The
Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
current reports on Form 8-K, and any amendments to such reports filed
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934,
as amended, are made available free of charge on its website, www.cbtc.com, as soon as reasonably
practicable after such reports are electronically filed with the Securities and
Exchange Commission.  Information on the website should not be
considered a part of this Form 10-K.


1





Market
Area





The Bank
considers its principal lending and deposit market area to consist of the
Tri-County area. These counties have experienced significant population growth
during the past decade due to their proximity to the growing Washington, DC and
Baltimore metropolitan areas.  Southern Maryland is generally
considered to have more affordable housing than many other Washington and
Baltimore area suburbs.  In addition, the area has experienced rapid
growth in the last decade in businesses and federal facilities located in the
area.  Major federal facilities include the Patuxent Naval Air Station
in St. Mary’s County.  The Patuxent Naval Air Station has undergone
significant expansion in the last several years and is projected to continue to
expand for several more years.




In the
last several years, residential housing and population growth in the Tri-County
area has been constrained by certain government policies designed to limit
growth. Growth has also been dampened as the demand for new housing in the
Tri-County area has fallen as the overall housing market has
fallen.  Future regulatory events may adversely affect the Bank’s loan
growth.





Competition





The Bank
faces strong competition in the attraction of deposits and in the origination of
loans.  Its most direct competition for deposits and loans comes from
other banks, savings and loan associations, and federal and state credit unions
located in its primary market area.  There are currently 14
FDIC-insured depository institutions operating in the Tri-County area including
subsidiaries of several regional and super-regional bank holding
companies.  According to statistics compiled by the FDIC, the Bank was
ranked third in deposit market share in the Tri-County area as of June 30, 2009,
the latest date for which such data is available. The Bank faces additional
significant competition for investors’ funds from mutual funds, brokerage firms,
and other financial institutions.  The Bank competes for loans by
providing competitive rates, flexibility of terms, and service. It competes for
deposits by offering depositors a wide variety of account types, convenient
office locations and competitive rates.  Other services offered
include tax-deferred retirement programs, brokerage services, and safe deposit
boxes.  The Bank has used direct mail, billboard and newspaper
advertising to increase its market share of deposits, loans and other services
in its market area.  It provides ongoing training for its staff in an
attempt to ensure high-quality service.





Lending
Activities





General.  The
Bank offers a wide variety of real estate, consumer and commercial
loans.  The Bank’s lending activities include residential and
commercial real estate loans, construction loans, land acquisition and
development loans, equipment financing and commercial and consumer
loans.  Most of the Bank’s customers are residents of, or businesses
located in, the Tri-County area.  The Bank’s primary market for
commercial loans consists of small and medium-sized businesses located in
Southern Maryland.  The Bank believes that this market is responsive
to the Bank’s ability to provide personal service and
flexibility.  The Bank attracts customers for its consumer lending
products based upon its ability to offer service, flexibility, and competitive
pricing, as well as by leveraging other banking relationships such as soliciting
deposit customers for loans.




Commercial Real
Estate and Other Non-Residential Real Estate Loans.  The
permanent financing of commercial and other improved real estate projects,
including office buildings, retail locations, churches, and other special
purpose buildings is the largest single component of the Bank’s loan
portfolio.  Commercial real estate loans amounted to $293.0 million,
or 46.9% of the loan portfolio, at December 31, 2009. This was an increase in
both absolute size and as a percentage of the loan portfolio.  The
commercial real estate loan portfolio was the one loan portfolio that increased
as a percentage of total loans during 2009. The primary security on a commercial
real estate loan is the real property and the leases that produce income for the
real property.  The Bank generally limits its exposure to a single
borrower to 15% of the Bank’s capital and participates with other lenders on
larger projects.  Loans secured by commercial real estate are
generally limited to 80% of the lower of the appraised value or sales price and
have an initial contractual loan payment period ranging from three to 20
years.  Virtually all of the Bank’s commercial real estate loans are
secured by real estate located in the Bank’s primary market area.  At
December 31, 2009, the largest outstanding commercial real estate loan was a
$7.6 million loan, which is secured by an office building. This loan was
performing according to its terms at December 31, 2009.


2


Loans
secured by commercial real estate are larger and involve greater risks than
one-to-four family residential mortgage loans.  Because payments on
loans secured by such properties are often dependent on the successful operation
or management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the
economy.  As a result of the greater emphasis that the Bank places on
commercial real estate loans, the Bank is increasingly exposed to the risks
posed by this type of lending.  To monitor cash flows on income
properties, the Bank requires borrowers and loan guarantors, if any, to provide
annual financial statements on multi-family or commercial real estate
loans.  In reaching a decision on whether to make a multi-family or
commercial real estate loan, the Bank considers the net operating income of the
property, the borrower’s expertise, credit history and profitability, and the
value of the underlying property.  Environmental surveys are generally
required for commercial real estate loans over $250,000.




Residential First
Mortgage Loans.Residential first
mortgage loans made by the Bank are generally long-term loans, amortized on a
monthly basis, with principal and interest due each month. The initial
contractual loan payment period for residential loans typically ranges from ten
to 30 years.  The Bank’s experience indicates that real estate loans
remain outstanding for significantly shorter time periods than their contractual
terms. Borrowers may refinance or prepay loans at their option, without
penalty.  The Bank originates both fixed-rate and adjustable-rate
residential first mortgages.





The Bank
offers fixed-rate residential first mortgages on a variety of terms including
loan periods from ten to 30 years and bi-weekly payment loans.  Total
fixed-rate loan products in our residential first mortgage portfolio amounted to
$105.3 million as of December 31, 2009.  Fixed-rate loans may be
packaged and sold to investors or retained in the Bank’s loan
portfolio.  Depending on market conditions, the Bank may elect to
retain the right to service the loans sold for a payment based upon a percentage
(generally 0.25% of the outstanding loan balance).  These servicing
rights may be sold to other qualified servicers.  As of December 31,
2009, the Bank serviced $37.2 million in residential mortgage loans for
others.





The Bank
also offers mortgages that are adjustable on a one-, three- and five-year basis
generally with limitations on upward adjustments of two percentage points per
repricing period and six percentage points over the life of the
loan.  The Bank primarily markets adjustable-rate loans with rate
adjustments based upon a United States Treasury Bill Index.  As of
December 31, 2009, the Bank had $10.9 million in adjustable-rate residential
mortgage loans.  The retention of adjustable-rate mortgage loans in
the Bank’s loan portfolio helps reduce the negative effects of increases in
interest rates on the Bank’s net interest income.  Under certain
conditions, however, the annual and lifetime limitations on interest rate
adjustments may limit the increases in interest rates on these
loans.  There are also unquantifiable credit risks resulting from
potential increased costs to the borrower as a result of repricing of
adjustable-rate mortgage loans.  During periods of rising interest
rates, the risk of default on adjustable-rate mortgage loans may increase due to
the upward adjustment of interest cost to the borrower.  In addition,
the initial interest rate on adjustable-rate loans is generally lower than that
on a fixed-rate loan of similar credit quality and size.




The Bank
makes residential first mortgage loans of up to 97% of the appraised value or
sales price of the property, whichever is less, to qualified owner-occupants
upon the security of single-family homes.  Non-owner occupied one- to
four-family loans are generally permitted to a maximum 80% loan-to-value of the
appraised value depending on the overall strength of the
application.  The Bank currently requires that substantially all
residential first mortgage loans with loan-to-value ratios in excess of 80%
carry private mortgage insurance to lower the Bank’s exposure to approximately
80% of the value of the property.  In certain cases, the borrower may
elect to borrow amounts in excess of 80% loan-to-value in the form of a second
mortgage.  The second mortgage will generally have a higher interest
rate and shorter repayment period than the first mortgage on the same
property.




All
improved real estate that serves as security for a loan made by the Bank must be
insured, in the amount and by such companies as may be approved by the Bank,
against fire, vandalism, malicious mischief and other hazards.  Such
insurance must be maintained through the entire term of the loan and in an
amount not less than that amount necessary to pay the Bank’s indebtedness in
full.




Construction and
Land Development Loans.  The Bank offers construction loans to
individuals and building contractors for the construction of one-to-four family
dwellings.  Construction loans totaled $21.3 million at December 31,
2009.  Loans to individuals primarily consist of
construction/permanent loans, which have fixed rates, payable monthly for the
construction period and are followed by a 30-year, fixed or adjustable-rate
permanent loan.  The Bank also provides construction and land
development loans to home building and real estate development
companies.  Generally, these loans are secured by the real estate
under construction as well as by guarantees of the principals
involved.  Draws are made upon satisfactory completion of predefined
stages of construction or development.  The Bank will typically lend
up to the lower of 80% of the appraised value or purchase
price.


3





In
addition, the Bank offers loans to acquire and develop land, as well as loans on
undeveloped, subdivided lots for home building by individuals. Land acquisition
and development loans totaled $41.2 million at December 31,
2009.  Bank policy requires that zoning and permits must be in place
prior to making development loans.





The
Bank’s ability to originate all types of residential construction and
development loans is heavily dependent on the continued demand for single-family
housing construction in the Bank’s market areas. As demand for newly constructed
housing has fallen, the Bank’s growth in these loans has slowed. Although
construction and development loan balances grew in 2009 by $4.9 million compared
to 2008, their percentage of the total loan portfolio fell from 10.5% at
December 31, 2008 to 10.0% at December 31, 2009. If the demand for new houses in
the Bank’s market areas continues to decline, this portion of its loan portfolio
may also decline. In addition, a continued decline in demand for new housing
might adversely affect the ability of borrowers to repay these loans. There can
be no assurance of the Bank’s ability to continue growth and profitability in
its construction lending activities in the event of such a decline.





Construction
and land development loans are inherently riskier than providing financing on
owner-occupied real estate.  The Bank’s risk of loss is affected by
the accuracy of the initial estimate of the market value of the completed
project as well as the accuracy of the cost estimates made to complete the
project.  In addition, the volatility of the real estate market has
made it increasingly difficult to ensure that  the valuation of land
associated with these loans is accurate.  During the construction
phase, a number of factors could result in delays and cost
overruns.  If the estimate of construction costs proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the development.  If the
estimate of value proves to be inaccurate, the Bank may be confronted, at or
before the maturity of the loan, with a project having a value that is
insufficient to assure full repayment.  As a result of these factors,
construction lending often involves the disbursement of substantial funds with
repayment dependent, in part, on the success of the  project rather
than the ability of the borrower or guarantor to repay principal and
interest.  If the Bank forecloses on a project, there can be no
assurance that the Bank will be able to recover all of the unpaid balance of,
and accrued interest on, the loan as well as related foreclosure and holding
costs.





Home Equity and
Second Mortgage Loans.The Bank maintains a
portfolio of home equity and second mortgage loans. Home equity loans, which
totaled $19.0 million at December 31, 2009, are generally made in the form of
lines of credit with minimum amounts of $5,000, have terms of up to 20 years,
variable rates priced at prime or some margin above prime, and require an 80% or
90% loan-to-value ratio (including any prior liens), depending on the specific
loan program.  Second mortgage loans, which totaled $6.1 million at
December 31, 2009, are fixed and variable-rate loans that have original terms
between five and 15 years.  Loan-to-value ratios of up to 80% or 95%
are allowed depending on the specific loan program.





These
products contain a higher risk of default than residential first mortgages as in
the event of foreclosure, the first mortgage would need to be paid off prior to
collection of the second mortgage.  This risk has been heightened as
the market value of residential property has declined.  The Bank is
monitoring the property values which secure its second mortgages and is lowering
credit availability where prudent.  The Bank believes that its
policies and procedures are sufficient to mitigate the additional risk posed by
these loans at the current time.





Commercial
Loans. The
Bank offers commercial loans to its business customers.  The Bank
offers a variety of commercial loan products including term loans and lines of
credit.  Such loans are generally made for terms of five years or
less.  The Bank offers both fixed-rate and adjustable-rate loans under
these product lines.  This portion of our portfolio has grown rapidly
in the last several years, growing from $52.7 million and 14.1% of the portfolio
at December 31, 2005 to $108.7 million and 17.4% of the overall loan portfolio
at December 31, 2009. When making commercial business loans, the Bank considers
the financial condition of the borrower, the borrower’s payment history of both
corporate and personal debt, the projected cash flows of the business, the
viability of the industry in which the consumer operates, the value of the
collateral, and the borrower’s ability to service the debt from
income.  These loans are primarily secured by equipment, real
property, accounts receivable, or other security as determined by the
Bank.  The higher interest rates and shorter loan terms available on
commercial lending make these products attractive to the
Bank.  Commercial business loans, however, entail greater risk than
residential mortgage loans.  Unlike residential mortgage loans, which
generally are made on the basis of the borrower’s ability to make repayment from
his or her employment or other income and which are secured by real property
whose value tends to be more easily ascertainable, commercial loans are made on
the basis of the borrower’s ability to make repayment from the cash flows of the
borrower’s business.  As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself.  In the case of business failure, collateral would
need to be liquidated to provide repayment for the loan.  In many
cases, the highly specialized nature of collateral equipment would make full
recovery from the sale of collateral problematic. The Bank attempts to control
these risks by establishing guidelines that provide for loans with low
loan-to-value ratios.  At December 31, 2009, the largest outstanding
commercial loan was $9.5 million, which was secured by commercial real estate,
cash and investments.  This loan was performing according to its terms
at December 31, 2009.


4





Consumer
Loans.  The Bank has developed a number of programs to serve
the needs of its customers with primary emphasis upon loans secured by
automobiles, boats, recreational vehicles and trucks.  The Bank also
makes home improvement loans and offers both secured and unsecured personal
lines of credit.  Consumer loans totaled $1.6 million at December 31,
2009.  The higher interest rates and shorter loan terms available on
consumer lending make these products attractive to the Bank.  Consumer
loans entail greater risk than residential mortgage loans, particularly in the
case of consumer loans, which are unsecured or secured by rapidly depreciating
assets such as automobiles.  In such cases, any repossessed collateral
may not provide an adequate source of repayment of the outstanding loan
balance.   Further collection efforts may be hampered by the
borrower’s lack of current income or other assets.  In addition,
consumer loan collections are dependent on the borrower’s continuing financial
stability and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy.  Furthermore, the application
of various federal and state laws including federal and state bankruptcy and
insolvency laws, may limit the amount that can be recovered on such
loans.  Such loans may also give rise to claims and defenses by a
consumer loan borrower against an assignee such as the Bank, and a borrower may
be able to assert against such assignee claims and defenses that it has against
the seller of the underlying collateral.




Commercial
Equipment Loans.The Bank also maintains
a commercial equipment financing portfolio. Commercial equipment loans totaled
$17.9 million, or 2.9% of the total loan portfolio, at December 31,
2009.  These loans consist primarily of fixed-rate, short-term loans
collateralized by customers’ equipment including trucks, cars, construction
equipment, and other more specialized equipment.  When making
commercial equipment loans, the Bank considers the same factors it considers
when underwriting a commercial business loan. The higher interest rates and
shorter loan terms available on commercial equipment lending make these products
attractive to the Bank.  These loans entail greater risk than loans
such as residential mortgage loans.  Unlike residential mortgage
loans, which generally are made on the basis of the borrower’s ability to make
repayment from his or her employment or other income and which are secured by
real property whose value tends to be more easily ascertainable, commercial
loans are of higher risk and typically are made on the basis of the borrower’s
ability to make repayment from the cash flow of the borrower’s
business.  As a result, the availability of funds for the repayment of
commercial loans may depend substantially on the success of the business
itself.  In the case of business failure, collateral would need to be
liquidated to provide repayment for the loan. In many cases, the highly
specialized nature of collateral equipment would make full recovery from the
sale of collateral problematic.  The Bank attempts to control these
risks by establishing guidelines that provide for over collateralization of the
loans.


5


Loan Portfolio
Analysis.  Set forth below is selected data relating to the
composition of the Bank’s loan portfolio by type of loan on the dates
indicated.




At December 31,2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %(Dollars in Thousands)Real
      Estate LoansCommercial
                  
                  $
                  292,988
                  
                  
                  
                  46.88
                  %
                  
                  $
                  236,410
                  
                  
                  
                  43.11
                  %
                  
                  $
                  190,484
                  
                  
                  
                  41.55
                  %
                  
                  $
                  181,933
                  
                  
                  
                  42.63
                  %
                  
                  $
                  170,096
                  
                  
                  
                  45.53
                  %Residential
      first mortgage
                  
                  
                  116,226
                  
                  
                  
                  18.59
                  %
                  
                  
                  104,607
                  
                  
                  
                  19.07
                  %
                  
                  
                  90,932
                  
                  
                  
                  19.83
                  %
                  
                  
                  80,781
                  
                  
                  
                  18.93
                  %
                  
                  
                  73,628
                  
                  
                  
                  19.71
                  %Construction
      and land development
                  
                  
                  62,509
                  
                  
                  
                  10.00
                  %
                  
                  
                  57,565
                  
                  
                  
                  10.50
                  %
                  
                  
                  50,577
                  
                  
                  
                  11.03
                  %
                  
                  
                  41,715
                  
                  
                  
                  9.77
                  %
                  
                  
                  31,450
                  
                  
                  
                  8.42
                  %Home
      equity and second mortgage
                  
                  
                  25,133
                  
                  
                  
                  4.02
                  %
                  
                  
                  25,412
                  
                  
                  
                  4.63
                  %
                  
                  
                  24,650
                  
                  
                  
                  5.38
                  %
                  
                  
                  24,572
                  
                  
                  
                  5.76
                  %
                  
                  
                  25,884
                  
                  
                  
                  6.93
                  %Commercial
      loans
                  
                  
                  108,658
                  
                  
                  
                  17.38
                  %
                  
                  
                  101,936
                  
                  
                  
                  18.59
                  %
                  
                  
                  75,247
                  
                  
                  
                  16.41
                  %
                  
                  
                  76,651
                  
                  
                  
                  17.96
                  %
                  
                  
                  52,651
                  
                  
                  
                  14.09
                  %Consumer
      loans
                  
                  
                  1,608
                  
                  
                  
                  0.26
                  %
                  
                  
                  2,046
                  
                  
                  
                  0.37
                  %
                  
                  
                  2,465
                  
                  
                  
                  0.54
                  %
                  
                  
                  2,813
                  
                  
                  
                  0.66
                  %
                  
                  
                  3,128
                  
                  
                  
                  0.84
                  %Commercial
      equipment
                  
                  
                  17,917
                  
                  
                  
                  2.87
                  %
                  
                  
                  20,458
                  
                  
                  
                  3.73
                  %
                  
                  
                  24,113
                  
                  
                  
                  5.26
                  %
                  
                  
                  18,288
                  
                  
                  
                  4.29
                  %
                  
                  
                  16,742
                  
                  
                  
                  4.48
                  %Total
      loans
                  
                  
                  625,039
                  
                  
                  
                  100.00
                  %
                  
                  
                  548,434
                  
                  
                  
                  100.00
                  %
                  
                  
                  458,468
                  
                  
                  
                  100.00
                  %
                  
                  
                  426,754
                  
                  
                  
                  100.00
                  %
                  
                  
                  373,579
                  
                  
                  
                  100.00
                  %Less:  Deferred
      loan fees
                  
                  
                  975
                  
                  
                  
                  
                  
                  
                  
                  311
                  
                  
                  
                  
                  
                  
                  
                  371
                  
                  
                  
                  
                  
                  
                  
                  490
                  
                  
                  
                  
                  
                  
                  
                  604Loan
      loss reserve
                  
                  
                  7,471
                  
                  
                  
                  
                  
                  
                  
                  5,146
                  
                  
                  
                  
                  
                  
                  
                  4,482
                  
                  
                  
                  
                  
                  
                  
                  3,784
                  
                  
                  
                  
                  
                  
                  
                  3,383Loans
      receivable, net
                  
                  $
                  616,593
                  
                  
                  
                  
                  
                  
                  $
                  542,977
                  
                  
                  
                  
                  
                  
                  $
                  453,614
                  
                  
                  
                  
                  
                  
                  $
                  422,480
                  
                  
                  
                  
                  
                  
                  $
                  369,592


6




Loan
Originations, Purchases and Sales.  The Bank solicits loan
applications through marketing by commercial and residential mortgage loan
officers, its branch network, and referrals from customers.  Loans are
processed and approved according to guidelines deemed appropriate for each
product type.  Loan requirements such as income verification,
collateral appraisal, and credit reports vary by loan type.  Loan
processing functions are generally centralized except for small consumer
loans.





Loan Approvals,
Procedures and Authority.  Loan approval authority is
established by Board policy and delegated as deemed necessary and
appropriate.  Loan approval authorities vary by individual with the
President having approval authority up to $1.25 million, Chief Lending Officer
$1.0 million, the Chief Credit Officer $1.0 million and the Chief Operating
Officer $500,000.  The individual lending authority of the other
lenders is set by management and based on their individual
abilities.  The loan approval authorities of the President, Chief
Lending Officer, the Chief Credit Officer and the Chief Operating Officer may be
combined and a minimum of at least two of the four need to be present in an
officers’ loan committee to approve loans up to $2.0 million. In cases where
time is of the essence, the officers’ loan committee consisting of any three
members may unanimously approve loans to relationships in excess of the $2.0
million up to the Bank’s in house lending limit with a later ratification by the
Board Credit Review Committee.  A loan committee consisting of at
least three members of the Board (the “Credit Review Committee”) ratifies all
commercial real estate loans and approves or renews all loans to relationships
that exceed $2.0 million, except for those noted above that exceed the $2.0
million limit in certain cases.  Depending on the loan and collateral
type, conditions for protecting the Bank’s collateral are specified in the loan
documents.  Typically these conditions might include requirements to
maintain hazard and title insurance and to pay property taxes.





Depending
on market conditions, mortgage loans may be originated primarily with the intent
to sell to third parties such as Fannie Mae or Freddie Mac.  Mortgage
loans in the amount of $21 million were sold by the Bank in 2009.  To
comply with internal and regulatory limits on loans to one borrower, the Bank
routinely sells portions of commercial and commercial real estate loans to other
lenders.  The Bank sold $4.2 million in participations in
2009.  The Bank also routinely buys loans, portions of loans, or
participation certificates from other lenders.  The Bank only
purchases loans or portions of loans after reviewing loan documents,
underwriting support, and other procedures, as necessary.  The Bank
purchased no participations in 2009.  Purchased participation loans
are subject to the same regulatory and internal policy requirements as other
loans in the Bank’s portfolio.





Loans to One
Borrower.  Under Maryland law, the maximum amount that the Bank
is permitted to lend to any one borrower and his or her related interests may
generally not exceed 10% of the Bank’s unimpaired capital and surplus, which is
defined to include the Bank’s capital, surplus, retained earnings and 50% of its
reserve for possible loan losses.  Under this authority, the Bank
would have been permitted to lend up to $8.2 million to any one borrower at
December 31, 2009.  By interpretive ruling of the Commissioner of
Financial Regulation, Maryland banks have the option of lending up to the amount
that would be permissible for a national bank, which is generally 15% of
unimpaired capital and surplus (defined to include a bank’s total capital for
regulatory capital purposes plus any loan loss allowances not included in
regulatory capital).  Under this formula, the Bank would have been
permitted to lend up to $12.8 million to any one borrower at December 31, 2009.
At December 31, 2009, the largest amount outstanding to any one borrower and his
or her related interests was $11 million.





Loan
Commitments.  The Bank does not normally negotiate standby
commitments for the construction and purchase of real
estate.  Conventional loan commitments are granted for a one-month
period.  The Bank’s outstanding commitments to originate loans at
December 31, 2009 were approximately $12.2 million, excluding undisbursed
portions of loans in process.  It has been the Bank’s experience that
few commitments expire unfunded.


7





Maturity of Loan
Portfolio.  The following table sets forth certain information
at December 31, 2009 regarding the dollar amount of loans maturing in the Bank’s
portfolio based on their contractual terms to maturity.  Demand loans,
loans having no stated schedule of repayments and no stated maturity, and
overdrafts are reported as due in one year or less.





Due within one
                  
                  
                  Due after one
                    year through
                  
                  
                  Due more thanyear after
                  
                  
                  five years from
                  
                  
                  five years fromDecember 31, 2009
                  
                  
                  December 31, 2009
                  
                  
                  December 31, 2009(In thousands)Real
      Estate LoansCommercial
                  
                  $
                  31,440
                  
                  
                  $
                  44,261
                  
                  
                  $
                  217,287Residential
      first mortgage
                  
                  
                  26,115
                  
                  
                  
                  59,919
                  
                  
                  
                  30,192Construction
      and land development
                  
                  
                  60,585
                  
                  
                  
                  1,657
                  
                  
                  
                  267Home
      equity and second mortgage
                  
                  
                  5,436
                  
                  
                  
                  12,157
                  
                  
                  
                  7,540Commercial
      lines of credit
                  
                  
                  108,658
                  
                  
                  
                  -
                  
                  
                  
                  -Consumer
      loans
                  
                  
                  394
                  
                  
                  
                  603
                  
                  
                  
                  611Commercial
      equipment
                  
                  
                  15,384
                  
                  
                  
                  2,533
                  
                  
                  
                  -Total
      loans
                  
                  $
                  248,012
                  
                  
                  $
                  121,130
                  
                  
                  $
                  255,897





The
following table sets forth the dollar amount of all loans due after one year
from December 31, 2009, which have predetermined interest rates and have
floating or adjustable interest rates.





Floating orFixed Rates
                  
                  
                  Adjustable Rates
                  
                  
                  Total(In thousands)Real
      Estate LoansCommercial
                  
                  $
                  39,057
                  
                  
                  $
                  222,491
                  
                  
                  $
                  261,548Residential
      first mortgage
                  
                  
                  82,274
                  
                  
                  
                  7,837
                  
                  
                  
                  90,111Construction
      and land development
                  
                  
                  100
                  
                  
                  
                  1,824
                  
                  
                  
                  1,924Home
      equity and second mortgage
                  
                  
                  3,141
                  
                  
                  
                  16,556
                  
                  
                  
                  19,697Commercial
      lines of credit
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Consumer
      loans
                  
                  
                  1,214
                  
                  
                  
                  -
                  
                  
                  
                  1,214Commercial
      equipment
                  
                  
                  2,533
                  
                  
                  
                  -
                  
                  
                  
                  2,533$
                  128,319
                  
                  
                  $
                  248,708
                  
                  
                  $
                  377,027





Delinquencies.  The
Bank’s collection procedures provide that when a loan is 15 days delinquent, the
borrower is contacted by mail and payment is requested.  If the
delinquency continues, subsequent efforts will be made to contact the delinquent
borrower and obtain payment.  If these efforts prove unsuccessful, the
Bank will pursue appropriate legal action including repossession of the
collateral and other actions as deemed necessary.  In certain
instances, the Bank will attempt to modify the loan or grant a limited
moratorium on loan payments to enable the borrower to reorganize his financial
affairs.




Non-Performing
Assets and Asset Classification.  Loans are reviewed on a
regular basis and are placed on non-accrual status when, in the opinion of
management, the collection of additional interest is
doubtful.  Residential mortgage loans are placed on non-accrual status
when either principal or interest is 90 days or more past due unless they are
adequately secured and there is reasonable assurance of full collection of
principal and interest.  Consumer loans generally are charged off when
the loan becomes more than 180 days delinquent.  Commercial business
and real estate loans are placed on non-accrual status when the loan is 90 days
or more past due or when the loan’s condition puts the timely repayment of
principal and interest in doubt.  Interest accrued and unpaid at the
time a loan is placed on non-accrual status is charged against interest
income.  Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending on management’s
assessment of the ultimate collectability of the loan The interest on these
loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual.  Loans are returned to accrual
status when all principal and interest amounts contractually due are brought
current and future payments are reasonably assured.


8




Foreclosed Real
Estate.Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as foreclosed real
estate until such time as it is sold.  When such property is acquired,
it is recorded at its fair market value.  Subsequent to foreclosure,
the property is carried at the lower of cost or fair value less selling
costs.  Additional write-downs as well as carrying expenses of the
foreclosed properties are charged to expenses in the current period. The Bank
had foreclosed real estate with a carrying value of approximately $922,934 at
December 31, 2009.





Delinquent and
Nonaccrual Loans.As of December 31, 2009, the Bank had loans in the
amount of $10,622,173 considered impaired loans.  Included in this
amount is one troubled debt restructuring accruing loan of
$1,675,000.  Loan loss reserves of $1,837,345 relate to impaired loans
at December 31, 2009.





The
following table sets forth information with respect to the Bank’s troubled debt
restructured, non-performing, and impaired loans for the dates indicated. At
each of the dates indicated, there were no accruing loans which are
contractually past due 90 days or more.





2009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005(Dollars in Thousands)Restructured
      Loans
                    
                    $
                    11,601
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Non-performing loansImpaired
      loans on which recognition of interest has been
    discontinued
                    
                    $
                    8,947
                    
                    
                    $
                    1,743
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Loans
      on which recognition of interest has been discontinued
                    
                    
                    10,340
                    
                    
                    
                    3,193
                    
                    
                    
                    414
                    
                    
                    
                    1,046
                    
                    
                    
                    591Total
      non-performing loans
                    
                    $
                    19,287
                    
                    
                    $
                    4,936
                    
                    
                    $
                    414
                    
                    
                    $
                    1,046
                    
                    
                    $
                    591Impaired loansRestructured
      loans and specific identification
                    
                    $
                    1,675
                    
                    
                    $
                    -
                    
                    
                    $
                    755
                    
                    
                    $
                    -
                    
                    
                    $
                    -Loans
      accounted for on a non-accrual basis
                    
                    
                    8,947
                    
                    
                    
                    1,743
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Total
      impaired loans
                    
                    $
                    10,622
                    
                    
                    $
                    1,743
                    
                    
                    $
                    755
                    
                    
                    $
                    -
                    
                    
                    $
                    -Non-performing
      loans to total loans
                    
                    
                    3.09
                    %
                    
                    
                    0.90
                    %
                    
                    
                    0.09
                    %
                    
                    
                    0.25
                    %
                    
                    
                    0.16
                    %Allowance
      for loan losses to non-performing loans
                    
                    
                    38.74
                    %
                    
                    
                    104.25
                    %
                    
                    
                    1082.61
                    %
                    
                    
                    361.76
                    %
                    
                    
                    572.42
                    %





The below
schedule provides the details by loan portfolio of non-performing loans for
the dates indicated. The largest concentration of non-performing loans is
construction and land development portfolio loans which have been particularly
affected by recent economic factors that have slowed absorption of finished lots
and homes. Other loan types have also been affected by the economic conditions
in our local and national markets. At December 31, 2009 $17.7 million or 91.9%
of the Bank’s non-performing loans represent four customer relationships. The
Bank’s non-performing loans are predominantly collateralized. Management
continues to monitor these loans and is working to resolve these loans in a
manner which will, in our opinion, preserve the most value for the
Company.


9





At December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005(In Thousands)Loans
      accounted for on a nonaccrual basis:Real
      Estate LoansCommercial
                
                $
                6,367
                
                
                $
                1,208
                
                
                $
                -
                
                
                $
                390
                
                
                $
                -Residential
      first mortgage
                
                
                339
                
                
                
                -
                
                
                
                274
                
                
                
                273
                
                
                
                273Construction
      and land development
                
                
                9,504
                
                
                
                1,840
                
                
                
                -
                
                
                
                -
                
                
                
                -Home
      equity and second mortgage
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                53Commercial
      loans
                
                
                2,192
                
                
                
                903
                
                
                
                60
                
                
                
                303
                
                
                
                258Consumer
      loans
                
                
                23
                
                
                
                148
                
                
                
                80
                
                
                
                80
                
                
                
                7Commercial
      equipment
                
                
                862
                
                
                
                837
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
                
                $
                19,287
                
                
                $
                4,936
                
                
                $
                414
                
                
                $
                1,046
                
                
                $
                591





During
the year ended December 31, 2009, gross interest income of $1,285,000 would have
been recorded on loans accounted for on a non-accrual basis if the loans had
been current throughout the period.  During 2009, the Company
recognized $268,000 in interest on these loans.


10





The
following table sets forth an analysis of activity in the Bank’s allowance for
loan losses for the periods indicated.





At December 31,2009
                          
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005(Dollars in Thousands)Balance
      at beginning of period
                          
                          $
                          5,146
                          
                          
                          $
                          4,482
                          
                          
                          $
                          3,784
                          
                          
                          $
                          3,383
                          
                          
                          $
                          3,058Charge-offs:Real
      Estate LoansCommercial
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          29
                          
                          
                          
                          -
                          
                          
                          
                          -Construction
      and land development
                          
                          
                          187
                          
                          
                          
                          287
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Home
      equity and second mortgage
                          
                          
                          98
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Commercial
      loans
                          
                          
                          608
                          
                          
                          
                          202
                          
                          
                          
                          73
                          
                          
                          
                          -
                          
                          
                          
                          3Consumer
      loans
                          
                          
                          32
                          
                          
                          
                          67
                          
                          
                          
                          56
                          
                          
                          
                          8
                          
                          
                          
                          2Commercial
      equipment
                          
                          
                          223
                          
                          
                          
                          83
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          4Total
      Charge-offs:
                          
                          
                          1,148
                          
                          
                          
                          639
                          
                          
                          
                          158
                          
                          
                          
                          8
                          
                          
                          
                          9Recoveries:Residential
      first mortgage
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Consumer
      loans
                          
                          
                          -
                          
                          
                          
                          2
                          
                          
                          
                          2
                          
                          
                          
                          3
                          
                          
                          
                          -Commercial
      equipment
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          5Total
      Recoveries
                          
                          
                          -
                          
                          
                          
                          2
                          
                          
                          
                          2
                          
                          
                          
                          3
                          
                          
                          
                          5Net
      charge-offs
                          
                          
                          1,148
                          
                          
                          
                          637
                          
                          
                          
                          156
                          
                          
                          
                          5
                          
                          
                          
                          4Provision
      for Possible Loan Losses
                          
                          
                          3,473
                          
                          
                          
                          1,301
                          
                          
                          
                          855
                          
                          
                          
                          406
                          
                          
                          
                          329Balance
      at End of Period
                          
                          $
                          7,471
                          
                          
                          $
                          5,146
                          
                          
                          $
                          4,482
                          
                          
                          $
                          3,784
                          
                          
                          $
                          3,383Allowance
      for loan losses to total loans
                          
                          
                          1.20
                          %
                          
                          
                          0.94
                          %
                          
                          
                          0.98
                          %
                          
                          
                          0.89
                          %
                          
                          
                          0.91
                          %Net
      charge-offs to average loans
                          
                          
                          0.20
                          %
                          
                          
                          0.13
                          %
                          
                          
                          0.04
                          %
                          
                          
                          0.00
                          %
                          
                          
                          0.00
                          %


11


The
following table allocates the allowance for loan losses by loan category at the
dates indicated.  The allocation of the allowance to each category is
not necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.





At December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Amount
                
                
                Percent of
                  Loans in
                  Each
                  CategorytoTotalLoans
                
                
                Amount
                
                
                Percent of
                  Loans in
                  Each
                  CategorytoTotalLoans
                
                
                Amount
                
                
                Percent of
                  Loans in
                  Each
                  CategorytoTotalLoans
                
                
                Amount
                
                
                Percent of
                  Loans in
                  Each
                  CategorytoTotalLoans
                
                
                Amount
                
                
                Percent of
                  Loans in
                  Each
                  CategorytoTotalLoans(Dollars in Thousands)Real
      Estate LoansCommercial
                
                $
                2,660
                
                
                
                46.88
                %
                
                $
                2,009
                
                
                
                43.11
                %
                
                $
                1,739
                
                
                
                41.55
                %
                
                $
                1,479
                
                
                
                42.63
                %
                
                $
                1,466
                
                
                
                45.53
                %Residential
      first mortgage
                
                
                128
                
                
                
                18.59
                %
                
                
                105
                
                
                
                19.07
                %
                
                
                266
                
                
                
                19.83
                %
                
                
                97
                
                
                
                18.93
                %
                
                
                73
                
                
                
                19.71
                %Construction
      and land development
                
                
                1,696
                
                
                
                10.00
                %
                
                
                1,295
                
                
                
                10.50
                %
                
                
                1,125
                
                
                
                11.03
                %
                
                
                662
                
                
                
                9.77
                %
                
                
                502
                
                
                
                8.42
                %Home
      equity and second mortgage
                
                
                131
                
                
                
                4.02
                %
                
                
                102
                
                
                
                4.63
                %
                
                
                98
                
                
                
                5.38
                %
                
                
                104
                
                
                
                5.76
                %
                
                
                109
                
                
                
                6.93
                %Commercial
      loans
                
                
                2,110
                
                
                
                17.38
                %
                
                
                1,248
                
                
                
                18.59
                %
                
                
                930
                
                
                
                16.41
                %
                
                
                1,135
                
                
                
                17.96
                %
                
                
                709
                
                
                
                14.09
                %Consumer
      loans
                
                
                64
                
                
                
                0.26
                %
                
                
                43
                
                
                
                0.37
                %
                
                
                96
                
                
                
                0.54
                %
                
                
                126
                
                
                
                0.66
                %
                
                
                124
                
                
                
                0.84
                %Commercial
      equipment
                
                
                682
                
                
                
                2.87
                %
                
                
                344
                
                
                
                3.73
                %
                
                
                228
                
                
                
                5.26
                %
                
                
                181
                
                
                
                4.29
                %
                
                
                400
                
                
                
                4.48
                %Total
      allowance for loan losses
                
                $
                7,471
                
                
                
                100.00
                %
                
                $
                5,146
                
                
                
                100.00
                %
                
                $
                4,482
                
                
                
                100.00
                %
                
                $
                3,784
                
                
                
                100.00
                %
                
                $
                3,383
                
                
                
                100.00
                %


12


The Bank
closely monitors the loan payment activity of all its loans.  The Bank
periodically reviews the adequacy of the allowance for loan losses based on an
analysis of the size and composition of the loan portfolio, the Bank’s
historical loss experience, including trends in non-performing and classified
loans and charge-offs, economic conditions in the Bank’s market area, and a
review of selected individual loans.  Loan losses are charged off
against the allowance when individual loans are deemed
uncollectible.  Subsequent recoveries, if any, are credited to the
allowance.  The Bank believes it has established its existing
allowance for loan losses in accordance with accounting principles generally
accepted in the United States of America and is in compliance with appropriate
regulatory guidelines.  However, the establishment of the level of the
allowance for loan losses is highly subjective and dependent on incomplete
information as to the ultimate disposition of loans.  Accordingly,
there can be no assurance that actual losses may not vary from the amounts
estimated or that the Bank’s regulators will not require the Bank to
significantly increase or decrease its allowance for loan losses, thereby
affecting the Bank’s financial condition and earnings.  For a more
complete discussion of the allowance for loan losses, see the section captioned
“Management’s Discussion and
Analysis of Financial Condition and Results of Operations—Critical Accounting
Policies” in the Company’s 2009 Annual Report to
Stockholders.





Investment
Activities





The Bank
maintains a portfolio of investment securities to provide liquidity as well as a
source of earnings.  The Bank’s investment securities portfolio
consists primarily of mortgage-backed and other securities issued by U.S.
government-sponsored enterprises (“GSEs”), including Freddie Mac and Fannie
Mae.  The Bank also has smaller holdings of privately issued
mortgage-backed securities, U.S. Treasury obligations, and other equity and debt
securities.  As a member of the Federal Reserve and FHLB system, the
Bank is also required to invest in the stock of the Federal Reserve Bank of
Richmond and FHLB of Atlanta.





The
following table sets forth the carrying value of the Company’s investment
securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the
dates indicated.  At December 31, 2009, 2008, and 2007, their
estimated fair value was $148 million, $124 million, and $106 million,
respectively.





(In Thousands)At December 31,2009
                            
                            
                            2008
                            
                            
                            2007Asset-backed
      securities:Freddie
      Mac and Fannie Mae
                            
                            $
                            121,510
                            
                            
                            $
                            93,049
                            
                            
                            $
                            72,072Other
                            
                            
                            19,006
                            
                            
                            
                            25,150
                            
                            
                            
                            25,283Total
      asset-backed securities
                            
                            
                            140,516
                            
                            
                            
                            118,199
                            
                            
                            
                            97,355Corporate
      Equity Securities
                            
                            
                            39
                            
                            
                            
                            157
                            
                            
                            
                            251Bond
      mutual funds
                            
                            
                            3,654
                            
                            
                            
                            3,560
                            
                            
                            
                            3,390Treasury
      bills
                            
                            
                            -
                            
                            
                            
                            1,000
                            
                            
                            
                            799Other
      Investments
                            
                            
                            5
                            
                            
                            
                            17
                            
                            
                            
                            37Total
      investment securities
                            
                            
                            144,214
                            
                            
                            
                            122,933
                            
                            
                            
                            101,832FHLB
      and Federal Reserve Bank stock
                            
                            
                            6,936
                            
                            
                            
                            6,453
                            
                            
                            
                            5,355Total
      investment securities and FHLBand
      Federal Reserve Bank stock
                            
                            $
                            151,150
                            
                            
                            $
                            129,386
                            
                            
                            $
                            107,187


13


The maturities and weighted average
yields for investment securities available for sale and held to maturity at
December 31, 2009 are shown below.





After One
                          
                          
                          After FiveOne Year or Less
                          
                          
                          Through Five Years
                          
                          
                          Through Ten Years
                          
                          
                          After Ten YearsAmortized
                          
                          
                          Average
                          
                          
                          Amortized
                          
                          
                          Average
                          
                          
                          Amortized
                          
                          
                          Average
                          
                          
                          Amortized
                          
                          
                          AverageCost
                          
                          
                          Yield
                          
                          
                          Cost
                          
                          
                          Yield
                          
                          
                          Cost
                          
                          
                          Yield
                          
                          
                          Cost
                          
                          
                          Yield(Dollars in Thousands)Investment
      securities available for
    sale:Corporate
      equity securities
                          
                          $
                          37
                          
                          
                          
                          1.15
                          %
                          
                          $
                          -
                          
                          
                          
                          0.00
                          %
                          
                          $
                          -
                          
                          
                          
                          0.00
                          %
                          
                          $
                          -
                          
                          
                          
                          0.00
                          %Asset-backed
      securities
                          
                          
                          24,888
                          
                          
                          
                          2.64
                          %
                          
                          
                          18,875
                          
                          
                          
                          2.68
                          %
                          
                          
                          4,670
                          
                          
                          
                          3.23
                          %
                          
                          
                          1,185
                          
                          
                          
                          3.49
                          %Mutual
      Funds
                          
                          
                          3,568
                          
                          
                          
                          3.63
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %Total
      investment securities available for
      sale
                          
                          $
                          28,493
                          
                          
                          
                          2.76
                          %
                          
                          $
                          18,875
                          
                          
                          
                          2.68
                          %
                          
                          $
                          4,670
                          
                          
                          
                          3.23
                          %
                          
                          $
                          1,185
                          
                          
                          
                          3.49
                          %Investment
      securities held-to-maturity:Asset-backed
      securities
                          
                          $
                          41,955
                          
                          
                          
                          3.90
                          %
                          
                          $
                          38,934
                          
                          
                          
                          4.13
                          %
                          
                          $
                          8,041
                          
                          
                          
                          4.16
                          %
                          
                          $
                          1,353
                          
                          
                          
                          3.89
                          %Treasury
      bills
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %Other
      investments
                          
                          
                          5
                          
                          
                          
                          3.14
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %
                          
                          
                          -
                          
                          
                          
                          0.00
                          %Total
      investment securities held-to-maturity
                          
                          $
                          41,960
                          
                          
                          
                          3.90
                          %
                          
                          $
                          38,934
                          
                          
                          
                          4.13
                          %
                          
                          $
                          8,041
                          
                          
                          
                          4.16
                          %
                          
                          $
                          1,353
                          
                          
                          
                          3.89
                          %





The
Bank’s investment policy provides that securities that will be held for
indefinite periods of time, including securities that will be used as part of
the Bank’s asset/liability management strategy and that may be sold in response
to changes in interest rates, prepayments and similar factors, are classified as
available for sale and accounted for at fair value.  Management’s
intent is to hold securities reported at amortized cost to
maturity.  Certain of the Company’s asset-backed securities are issued
by private issuers (defined as an issuer that is not a government or a
government-sponsored entity).  The Company had no investments in any
private issuer’s securities that aggregate to more than 10% of the Company’s
equity.





Deposits
and Other Sources of Funds





General.  The
funds needed by the Bank to make loans are primarily generated by deposit
accounts solicited from the communities surrounding its main office and nine
branches in the Southern Maryland area.  Total deposits were $640.4
million as of December 31, 2009. The Bank uses borrowings, reverse repurchase
agreements, and other sources to supplement funding from deposits.





Deposits.The Bank’s deposit
products include savings, money market, demand deposit, IRA, SEP, Christmas
clubs, and time deposit accounts.  Variations in service charges,
terms and interest rates are used to target specific markets. Ancillary products
and services for deposit customers include safe deposit boxes, travelers checks,
night depositories, automated clearinghouse transactions, wire transfers, ATMs,
and online and telephone banking. The Bank is a member of ACCEL/Exchange,
Cirrus, Maestro and Star ATM networks.  The Bank has occasionally used
deposit brokers to obtain funds.  At December 31, 2009, the Bank had
$20 million in deposits from brokers compared to $19.3 million at
December 31, 2008. In addition the Bank utilizes the Certificate of Deposit
Account Registry Service (CDARS) to provide existing customers with additional
access to FDIC insurance. At December 31, 2009, the Bank maintained CDARS
deposits of $39.1 million compared to $42.4 million at December 31,
2008.


14





The
following table sets forth for the periods indicated the average balances
outstanding and average interest rates for each major category of
deposits.





For the Year Ended December 31,(Dollars in Thousands)2009
                    
                    
                    2008
                    
                    
                    2007Average
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    AverageBalance
                    
                    
                    Rate
                    
                    
                    Balance
                    
                    
                    Rate
                    
                    
                    Balance
                    
                    
                    RateSavings
                    
                    $
                    28,487
                    
                    
                    
                    0.16%
                    
                    
                    $
                    26,435
                    
                    
                    
                    0.59%
                    
                    
                    $
                    28,391
                    
                    
                    
                    0.97%Interest-bearing
      demand andmoney
      market accounts
                    
                    
                    142,513
                    
                    
                    
                    1.02%
                    
                    
                    
                    132,512
                    
                    
                    
                    1.75%
                    
                    
                    
                    137,001
                    
                    
                    
                    3.00%Certificates
      of deposit
                    
                    
                    355,488
                    
                    
                    
                    3.02%
                    
                    
                    
                    268,363
                    
                    
                    
                    3.93%
                    
                    
                    
                    222,769
                    
                    
                    
                    4.72%Total
      interest-bearing deposits
                    
                    
                    526,488
                    
                    
                    
                    
                    
                    
                    
                    427,310
                    
                    
                    
                    
                    
                    
                    
                    388,161
                    
                    
                    
                    3.84%Noninterest-bearing
      demand deposits
                    
                    
                    53,584
                    
                    
                    
                    
                    
                    
                    
                    42,955
                    
                    
                    
                    
                    
                    
                    
                    45,969$
                    580,072
                    
                    
                    
                    2.11%
                    
                    
                    $
                    470,265
                    
                    
                    
                    2.77%
                    
                    
                    $
                    434,130
                    
                    
                    
                    3.43%





The
following table indicates the amount of the Bank’s certificates of deposit and
other time deposits of $100,000 or more by time remaining until maturity as of
December 31, 2009.





CertificatesMaturity Period
                  
                  of Deposit(In thousands)Three
      months or less
                  
                  $
                  61,864Three
      through six months
                  
                  
                  33,725Six
      through twelve months
                  
                  
                  64,713Over
      twelve months
                  
                  
                  32,348Total
                  
                  $
                  192,650





Borrowings.  Deposits
are the primary source of funds for the Bank’s lending and investment activities
and for its general business purposes.  The Bank uses advances from
the FHLB of Atlanta to supplement the supply of funds it may lend and to meet
deposit withdrawal requirements.  Advances from the FHLB are secured
by the Bank’s stock in the FHLB, a portion of the Bank’s loan portfolio , and
certain investments.  Generally,  the Bank’s ability to
borrow from the FHLB of Atlanta is limited by its available collateral and also
by an overall limitation of 40% of assets. Further, short-term credit facilities
are available at the Federal Reserve Bank of Richmond and other commercial
banks.    Other short-term debt consists of notes payable to
the U.S. Treasury on treasury, tax and loan accounts.  Long-term debt
consists of adjustable-rate advances with rates based upon LIBOR, fixed-rate
advances, and convertible advances.  The table below sets forth
information about borrowings for the years indicated.





At or for the Year Ended December 31,(Dollars in Thousands)2009
                
                
                2008
                
                
                2007Long-term
      debtLong-term
      debt outstanding at end of period
                
                $
                75,670
                
                
                $
                104,963
                
                
                $
                86,005Weighted
      average rate on outstanding long-term debt at end of
period
                
                
                3.26
                %
                
                
                3.81
                %
                
                
                4.45
                %Maximum
      outstanding long-term debt of any month end
                
                
                100,692
                
                
                
                104,998
                
                
                
                96,042Average
      outstanding long-term debt, during period
                
                
                94,745
                
                
                
                102,112
                
                
                
                86,993Approximate
      average rate paid on long-term debt during period
                
                
                3.70
                %
                
                
                4.09
                %
                
                
                4.49
                %Short-term
      borrowingsShort-term
      borrowings outstanding at end of period at end of period
                
                $
                13,081
                
                
                $
                1,522
                
                
                $
                1,555Weighted
      average rate on short-term borrowings at end of period
                
                
                0.34
                %
                
                
                1.83
                %
                
                
                3.58
                %Maximum
      outstanding short-term borrowings at any month end duringperiod
                
                $
                13,081
                
                
                $
                20,943
                
                
                $
                5,555Average
      outstanding short-term borrowings
                
                
                1,421
                
                
                
                4,355
                
                
                
                2,902Approximate
      average rate paid on short-term borrowings
                
                
                2.06
                %
                
                
                3.59
                %
                
                
                3.51
                %





For more
information regarding the Bank’s borrowings, see Note 10 of Notes to
Consolidated Financial Statements.


15





Subsidiary
Activities





In April
1997, the Bank formed a wholly owned subsidiary, Community Mortgage Corporation
of Tri-County, to offer mortgage banking, brokerage, and other services to the
public.  This corporation is currently inactive.





The
Company has two direct subsidiaries other than the Bank.  In July
2004, Tri-County Capital Trust I was established as a statutory trust under
Delaware law as a wholly-owned subsidiary of the Company to issue trust
preferred securities.  Tri-County Capital Trust I issued $7.0 million
of trust preferred securities on July 22, 2004.  In June 2005,
Tri-County Capital Trust II was also established as a statutory trust under
Delaware law as a wholly owned subsidiary of the Company to issue trust
preferred securities.  Tri-County Capital Trust II issued $5.0 million
of trust preferred securities on June 15, 2005.





SUPERVISION
AND REGULATION





Regulation
of the Company




General.  The
Company is a public company registered with the Securities and Exchange
Commission (the “SEC”) and, as the sole stockholder of the Bank, it is a bank
holding company and registered as such with the Board of Governors of the
Federal Reserve System (the “FRB”).  Bank holding companies are
subject to comprehensive regulation by the FRB under the Bank Holding Company
Act of 1956, as amended (the “BHCA”), and the regulations of the
FRB.  As a public company the Company is required to file annual,
quarterly and current reports with the SEC, and as a bank holding company, the
Company is required to file with the FRB annual reports and such additional
information as the FRB may require, and is subject to regular examinations by
the FRB.  The FRB also has extensive enforcement authority over bank
holding companies, including, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders, and to require
that a holding company divest subsidiaries (including its bank
subsidiaries).  In general, enforcement actions may be initiated for
violations of law and regulations and unsafe or unsound
practices.  The following discussion summarizes certain of the
regulations applicable to the Company but does not purport to be a complete
description of such regulations and is qualified in its entirety by reference to
the actual laws and regulations involved.




Under the
BHCA, a bank holding company must obtain FRB approval before:
(1) acquiring, directly or indirectly, ownership or control of any voting
shares of another bank or bank holding company if, after such acquisition, it
would own or control more than 5% of such shares (unless it already owns or
controls the majority of such shares); (2) acquiring all or substantially all of
the assets of another bank or bank holding company; or (3) merging or
consolidating with another bank holding company.  In evaluating such
application, the FRB considers factors such as the financial condition and
managerial resources of the companies involved, the convenience and needs of the
communities to be served and competitive factors.




The Riegle-Neal Interstate Banking and
Branching Efficiency of 1994 (the “Riegle-Neal Act”) authorized the FRB to
approve an application of a bank holding company meeting certain qualitative
criteria to acquire control of, or acquire all or substantially all of the
assets of, a bank located in a state other than such holding company’s home
state, without regard to whether the transaction is prohibited by the laws of
any state.  The FRB may not approve the acquisition of a bank that has
not been in existence for the minimum time period (not exceeding five years)
specified by the statutory law of the host state.  The Riegle-Neal Act
also prohibits the FRB from approving such an application if the applicant (and
its depository institution affiliates) controls or would control more than 10%
of the insured deposits in the United States or 30% or more of the deposits in
the target bank’s home state or in any state in which the target bank maintains
a branch.  The Riegle-Neal Act does not affect the authority of states
to limit the percentage of total insured deposits in the state that may be held
or controlled by a bank or bank holding company to the extent such limitation
does not discriminate against out-of-state banks or bank holding
companies.  Individual states may also waive the 30% state-wide
concentration limit contained in the Riegle-Neal Act.  Under Maryland
law, a bank holding company is prohibited from acquiring control of any bank if
the bank holding company would control more than 30% of the total deposits of
all depository institutions in the State of Maryland unless waived by the
Commissioner of Financial Regulation.


16




Additionally, the federal banking
agencies are authorized to approve interstate bank merger transactions without
regard to whether such transaction is prohibited by the law of any state, unless
the home state of one of the banks opted out of the Riegle-Neal Act by adopting
a law after the date of enactment of the Riegle-Neal Act and prior to June 1,
1997, which applies equally to all out-of-state banks and expressly prohibits
merger transactions involving out-of-state banks.  The State of
Maryland did not pass such a law during this period.  Interstate
acquisitions of branches are permitted only if the law of the state in which the
branch is located permits such acquisitions.  Interstate mergers and
branch acquisitions are also subject to the nationwide and statewide insured
deposit concentration amounts described above.




The BHCA also prohibits a bank holding
company, with certain exceptions, from acquiring direct or indirect ownership or
control of more than 5% of the voting shares of any company that is not a bank
or bank holding company, or from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks, or providing
services for its subsidiaries.  The principal exceptions to these
prohibitions involve certain non-bank activities which, by statute or by FRB
regulation or order, have been identified as activities closely related to the
business of banking or managing or controlling banks.  The list of
activities permitted by the FRB includes, among other things, operating a
savings institution, mortgage company, finance company, credit card company or
factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an insurance
agent for certain types of credit-related insurance; leasing property on a
full-payout, non-operating basis; selling money orders, travelers’ checks and
United States Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain
limitations, providing securities brokerage services for customers.




Effective with the enactment of the
Gramm-Leach-Bliley Act (the “G-L-B Act”), bank holding companies whose financial
institution subsidiaries are “well capitalized” and “well managed” and have
satisfactory Community Reinvestment Act records can elect to become “financial
holding companies,” which are permitted to engage in a broader range of
financial activities than are permitted to bank holding
companies.  Financial holding companies are authorized to engage in,
directly or indirectly, financial activities.  A financial activity is
an activity that is: (1) financial in nature; (2) incidental to an activity that
is financial in nature; or (3) complementary to a financial activity and that
does not pose a safety and soundness risk.  The G-L-B Act includes a
list of activities that are deemed to be financial in nature.  Other
activities also may be decided by the FRB to be financial in nature or
incidental thereto if they meet specified criteria.  A financial
holding company that intends to engage in a new activity to acquire a company to
engage in such an activity is required to give prior notice to the
FRB.  If the activity is not either specified in the G-L-B Act as
being a financial activity or one that the FRB has determined by rule or
regulation to be financial in nature, the prior approval of the FRB is
required.  To date, the Company has not elected to be come a financial
holding company




Federal law provides that no person
(broadly defined to include business entities) “directly or indirectly or acting
in concert with one or more persons, or through one or more subsidiaries, or
through one or more transactions,” may acquire “control” of a bank holding
company or insured bank without the approval of the appropriate federal
regulator, which in the Company’s (and Bank’s) case is the
FRB.  Control is defined to mean direct or indirect ownership, control
of, or holding irrevocable proxies representing 25% or more of any class of
voting stock, control in any manner of the election of a majority of the bank’s
directors or a determination by the FRB that the acquirer has or would have the
power to direct, or directly or indirectly to exercise a controlling influence
over, the management or policies of the institution.  Acquisition of
more than 10% of any class of stock creates a rebuttable presumption of control
under certain circumstances that requires that a filing be made with the FRB
unless the FRB determines that the presumption has been rebutted.  Any
company that seeks to acquire 25% or more of a class of a bank’s voting stock,
or otherwise acquire control, must first receive the prior approval of the FRB
under the Bank Holding Company Act and no existing bank holding company may
acquire more than 5% of any class of a nonsubsidiary bank’s voting stock without
prior FRB approval.




The Maryland Financial Institutions
Code prohibits a bank holding company from acquiring more than 5% of any class
of voting stock of a bank or bank holding company without the approval of the
Commissioner of Financial Regulation, except as otherwise expressly permitted by
federal law or in certain other limited situations.  The Maryland
Financial Institutions Code additionally prohibits any person from acquiring
voting stock in a bank or bank holding company without 60 days prior notice to
the Commissioner if such acquisition will give the person control of 25% or more
of the voting stock of the bank or bank holding company or will affect the power
to direct or to cause the direction of the policy or management of the bank or
bank holding company.  Any doubt whether the stock acquisition will
affect the power to direct or cause the direction of policy or management shall
be resolved in favor of reporting to the Commissioner.  The
Commissioner may deny approval of the acquisition if the Commissioner determines
it to be anti-competitive or to threaten the safety or soundness of a banking
institution.  Voting stock acquired in violation of this statute may
not be voted for five years.


17




Dividends.  The
FRB has issued a policy statement on the payment of cash dividends by bank
holding companies, which expresses the FRB’s view that a bank holding company
should pay cash dividends only to the extent that the company’s net income for
the past year is sufficient to cover both the cash dividends and a rate of
earnings retention that is consistent with the company’s capital needs, asset
quality and overall financial condition.  The FRB also indicated that
it would be inappropriate for a company experiencing serious financial problems
to borrow funds to pay dividends.  Furthermore, under the prompt
corrective action regulations adopted by the FRB pursuant to Federal Deposit
Insurance Corporation Improvement Act (“FDICIA”), the FRB may prohibit a bank
holding company from paying any dividends if the holding company’s bank
subsidiary is classified as “undercapitalized.”




Stock
Repurchases.  Bank holding companies are required to give the
FRB prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the their
consolidated retained earnings.  The FRB may disapprove such a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, FRB order, or
any condition imposed by, or written agreement with, the FRB.  There
is an exception for this approval requirement for certain well-capitalized,
well-managed bank holding companies.




Capital
Requirements.  The FRB has established capital requirements,
similar to the capital requirements for state member banks, for bank holding
companies with consolidated assets of $500 million or more.  As of
December 31, 2009, the Company’s levels of consolidated regulatory capital
exceeded the FRB’s minimum requirements.




Regulation
of the Bank




General.  The
Bank is a Maryland commercial bank and its deposit accounts are insured by the
Deposit Insurance Fund of the FDIC.  The Bank is a member of the
Federal Reserve and FHLB systems.  The Bank is subject to supervision,
examination and regulation by Commissioner of Financial Regulation of the State
of Maryland (the “Commissioner”) and the FRB and to Maryland and federal
statutory and regulatory provisions governing such matters as capital standards,
mergers, and establishment of branch offices.  The FDIC, as deposit
insurer, has certain secondary examination and supervisory
authority.  The Bank is required to file reports with the Commissioner
and the FRB concerning its activities and financial condition and is required to
obtain regulatory approvals prior to entering into certain transactions,
including mergers with, or acquisitions of, other depository
institutions.




As an institution with federally
insured deposits, the Bank is subject to various operational regulations
promulgated by the FRB, including Regulation B (Equal Credit Opportunity),
Regulation D (Reserve Requirements), Regulation E (Electronic Fund Transfers),
Regulation P (Privacy), Regulation W (Transactions Between Member Banks and
Their Affiliates), Regulation Z (Truth in Lending), Regulation CC (Availability
of Funds and Collection of Checks) and Regulation DD (Truth in
Savings).




The system of regulation and
supervision applicable to the Bank establishes a comprehensive framework for the
operations of the Bank and is intended primarily for the protection of the FDIC
and the depositors of the Bank.  The regulatory structure also gives
the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities, including with respect to the
classification of assets and the establishment of loss reserves for regulatory
purposes.  Changes in the regulatory framework could have a material
effect on the Bank and its respective operations that in turn, could have a
material effect on the Company.  The following discussion summarizes
certain regulations applicable to the Bank but does not purport to be a complete
description of such regulations and is qualified in its entirety by reference to
the actual laws and regulations involved.


18




Capital
Adequacy.  The FRB has established guidelines with respect to
the maintenance of appropriate levels of capital by bank holding companies and
state member banks, respectively.  The regulations impose two sets of
capital adequacy requirements: minimum leverage rules, which require bank
holding companies and member banks to maintain a specified minimum ratio of
capital-to-total assets, and risk-based capital rules, which require the
maintenance of specified minimum ratios of capital to “risk-weighted”
assets.




The regulations of the FRB require bank
holding companies and state member banks, respectively, to maintain a minimum
leverage ratio of “Tier 1 capital” (as defined in the risk-based capital
guidelines discussed in the following paragraphs) to total assets of
3.0%.  Although setting a minimum 3.0% leverage ratio, the capital
regulations state that only the strongest bank holding companies and banks, with
composite examination ratings of 1 under the rating system used by the federal
bank regulators, would be permitted to operate at or near such minimum level of
capital.  All other bank holding companies and banks are expected to
maintain a leverage ratio of at least 4.0%.  Any bank or bank holding
company experiencing or anticipating significant growth would be expected to
maintain capital well above the minimum levels.  In addition, the FRB
has indicated that whenever appropriate, and in particular when a bank holding
company is undertaking expansion, seeking to engage in new activities, or
otherwise facing unusual or abnormal risks, it will consider, on a case-by-case
basis, the level of an organization’s ratio of tangible Tier 1 capital (after
deducting all intangibles) to total assets in making an overall assessment of
capital.




The risk-based capital rules of the FRB
require bank holding companies and state member banks, respectively, to maintain
minimum regulatory capital levels based upon a weighting of their assets and
off-balance sheet obligations according to risk.  Risk-based capital
is composed of two elements: Tier 1 capital and Tier 2 capital.  Tier
1 capital consists primarily of common stockholders’ equity, certain perpetual
preferred stock (which must be noncumulative in the case of banks), and minority
interests in the equity accounts of consolidated subsidiaries; less all
intangible assets, except for certain servicing assets, purchased credit card
relationships, deferred tax assets and credit enhancing interest-only
strips.  Tier 2 capital elements include, subject to certain
limitations, the allowance for losses on loans and leases; perpetual preferred
stock that does not qualify as Tier 1 capital and long-term preferred stock with
an original maturity of at least 20 years from issuance; hybrid capital
instruments, including perpetual debt and mandatory convertible securities,
subordinated debt and intermediate-term preferred stock and up to 45% of
unrealized gains on available for sale equity securities with readily
determinable market values.




The risk-based capital regulations
assign balance sheet assets and credit equivalent amounts of off-balance sheet
obligations to one of four broad risk categories based principally on the degree
of credit risk associated with the obligor.  The assets and
off-balance sheet items in the four risk categories are weighted at 0%, 20%, 50%
and 100%.  These computations result in the total risk-weighted
assets.  The risk-based capital regulations require all banks and bank
holding companies to maintain a minimum ratio of total capital (Tier 1 capital
plus Tier 2 capital) to total risk-weighted assets of 8%, with at least 4% as
Tier 1 capital.  For the purpose of calculating these ratios: (i) Tier
2 capital is limited to no more than 100% of Tier 1 capital; and (ii) the
aggregate amount of certain types of Tier 2 capital is limited.  In
addition, the risk-based capital regulations limit the allowance for loan losses
includable as capital to 1.25% of total risk-weighted assets.




FRB regulations and guidelines
additionally specify that state member banks with significant exposure to
declines in the economic value of their capital due to changes in interest rates
may be required to maintain higher risk-based capital ratios.




The FRB has issued regulations that
classify state member banks by capital levels and which authorize the FRB to
take various prompt corrective actions to resolve the problems of any bank that
fails to satisfy the capital standards.  Under such regulations, a
well capitalized bank is one that is not subject to any regulatory order or
directive to meet any specific capital level and has or exceeds the following
capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based
capital ratio of 6%, and a leverage ratio of 5%.  An adequately
capitalized bank is one that does not qualify as well capitalized but meets or
exceeds the following capital requirements: a total risk-based capital ratio of
8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (1)
4% or (2) 3% if the bank has the highest composite examination
rating.  A bank not meeting these criteria is treated as
undercapitalized, significantly undercapitalized, or critically undercapitalized
depending on the extent to which the bank’s capital levels are below these
standards.  A state member bank that falls within any of the three
undercapitalized categories established by the prompt corrective action
regulation will be subject to regulatory sanctions.  As of December
31, 2009, the Bank was well capitalized as defined by the FRB’s
regulations.


19




Branching.  Maryland
law provides that, with the approval of the Commissioner, Maryland banks may
establish branches within the State of Maryland without geographic restriction
and may establish branches in other states by any means permitted by the laws of
such state or by federal law.  The Riegle-Neal Act authorizes the FRB
to approve interstate branching by merger by state member banks in any state
that did not opt out and de
novoin states that specifically allow for such branching.  The
Riegle-Neal Act also required the appropriate federal banking agencies to
prescribe regulations that prohibit any out-of-state bank from using the
interstate branching authority primarily for the purpose of deposit
production.  These regulations include guidelines to ensure that
interstate branches operated by an out-of-state bank in a host state are
reasonably helping to meet the credit needs of the communities which they
serve.




Dividend
Limitations.  Pursuant to the Maryland Financial Institutions
Code, Maryland banks may only pay dividends from undivided profits or, with the
prior approval of the Commissioner, their surplus in excess of 100% of required
capital stock.  The Maryland Financial Institutions Code further
restricts the payment of dividends by prohibiting a Maryland bank from declaring
a dividend on its shares of common stock until its surplus fund equals the
amount of required capital stock or, if the surplus fund does not equal the
amount of capital stock, in an amount in excess of 90% of net
earnings.




Without the approval of the FRB, a
state member bank may not declare or pay a dividend if the total of all
dividends declared during the year exceeds its net income during the current
calendar year and retained net income for the prior two years.  The
Bank is further prohibited from making a capital distribution if it would be
thereafter undercapitalized within the meaning of the prompt corrective action
regulations discussed above.  In addition, the Bank may not make a
capital distribution that would reduce its net worth below the amount required
to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.




Insurance of
Deposit Accounts.  The Bank’s deposits are insured up to
applicable limits by the Deposit Insurance Fund of the FDIC.  The
Deposit Insurance Fund is the successor to the Bank Insurance Fund and the
Savings Association Insurance Fund, which were merged in 2006.





Under the
FDIC’s risk-based assessment system, insured institutions are assigned to one of
four risk categories based on supervisory evaluations, regulatory capital levels
and certain other factors, with less risky institutions paying lower
assessments.  An institution’s assessment rate depends upon the
category to which it is assigned.  For calendar 2008, assessments
ranged from five to forty-three basis points of each institution’s deposit
assessment base.  Due to losses incurred by the Deposit Insurance Fund
in 2008 from failed institutions, and anticipated future losses, the FDIC
adopted, pursuant to a Restoration Plan to replenish the fund, an across the
board seven basis point increase in the assessment range for the first quarter
of 2009.  The FDIC made further refinements to its risk-based
assessment that were effective April 1, 2009 and effectively made the range
seven to 771/2 basis
points.  The FDIC may adjust the scale uniformly from one quarter to
the next, except that no adjustment can deviate more than three basis points
from the base scale without notice and comment rulemaking.  No
institution may pay a dividend if in default of the federal deposit insurance
assessment.





The FDIC
imposed on all insured institutions a special emergency assessment of five basis
points of total assets minus tier 1 capital, as of June 30, 2009 (capped at ten
basis points of an institution’s deposit assessment base), in order to cover
losses to the Deposit Insurance Fund. The Bank’s special emergency assessment
was $349,637, which was collected on September 30, 2009.  The FDIC
provided for similar assessments during the final two quarters of 2009, if
deemed necessary.  However, in lieu of further special assessments,
the FDIC required insured institutions to prepay estimated quarterly risk-based
assessments for the fourth quarter of 2009 through the fourth quarter of
2012.  The estimated assessments, which include an assumed annual
assessment base increase of 5%, were recorded as a prepaid expense asset as of
December 30, 2009 in the amount of $3.8 million.  As of December 31,
2009, and each quarter thereafter, a charge to earnings will be recorded for
each regular assessment with an offsetting credit to the prepaid
asset.


20


Due to the recent difficult economic
conditions, deposit insurance per account owner has been raised to $250,000 for
all types of accounts until January 1, 2014.  In addition, the FDIC
adopted an optional Temporary Liquidity Guarantee Program by which, for a fee,
noninterest bearing transaction accounts received unlimited insurance coverage
until December 31, 2009, subsequently extended until June 30,
2010.  Certain senior unsecured debt issued by institutions and their
holding companies during specified time periods could also be guaranteed by the
FDIC through June 30, 2012, or in some cases, December 31, 2012.  The
Bank made the business decision to participate in the unlimited noninterest
bearing transaction account coverage and the Bank optednot to participate in
the unsecured debt guarantee program.





Federal law also provides for the
possibility that the FDIC may pay dividends to insured institutions once the
Deposit Insurance fund reserve ratio equals or exceeds 1.35% of estimated
insured deposits.





In
addition to the assessment for deposit insurance, institutions are required to
make payments on bonds issued in the late 1980s by the Financing Corporation to
recapitalize a predecessor deposit insurance fund.  That payment is
established quarterly and during the four quarters ended December 31, 2009
averaged 1.06 basis points of assessable deposits.





The FDIC
has authority to increase insurance assessments.  A significant
increase in insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank.  Management
cannot predict what insurance assessment rates will be in the
future.





Insurance
of deposits may be terminated by the FDIC upon a finding that the institution
has engaged in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations or has violated any applicable law, regulation, rule,
order or condition imposed by the FDIC or the FRB.  The management of
the Bank does not know of any practice, condition or violation that might lead
to termination of deposit insurance.





Transactions with
Affiliates.  A state member bank or its subsidiaries may not
engage in “covered transactions” with any one affiliate in an amount greater
than 10% of such bank’s capital stock and surplus, and for all such transactions
with all affiliates a state member bank is limited to an amount equal to 20% of
capital stock and surplus.  All such transactions must also be on
terms substantially the same, or at least as favorable, to the bank or
subsidiary as those provided to a non-affiliate.  The term “covered
transaction” includes the making of loans, purchase of assets, issuance of a
guarantee and similar types of transactions.  Certain covered
transactions, such as loans to affiliates, must meet specified collateral
requirements.  An affiliate of a state member bank is any company or
entity that controls or is under common control with the state member bank and,
for purposes of the aggregate limit on transactions with affiliates, any
subsidiary that would be deemed a financial subsidiary of a national
bank.  In a holding company context, the parent holding company of a
state member bank (such as the Company) and any companies that are controlled by
such parent holding company are affiliates of the state member
bank.  The BHCA further prohibits a depository institution from
extending credit to or offering any other services, or fixing or varying the
consideration for such extension of credit or service, on the condition that the
customer obtain some additional service from the institution or certain of its
affiliates or not obtain services of a competitor of the institution, subject to
certain limited exceptions.




Loans to
Directors, Executive Officers and Principal Stockholders.Loans to directors,
executive officers and principal stockholders of a state member bank must be
made on substantially the same terms as those prevailing for comparable
transactions with persons who are not executive officers, directors, principal
stockholders or employees of the bank unless the loan is made pursuant to a
compensation or benefit plan that is widely available to employees and does not
favor insiders.  Loans to any executive officer, director and
principal stockholder together with all other outstanding loans to such person
and affiliated interests generally may not exceed 15% of the Bank’s unimpaired
capital and surplus and all loans to such persons may not exceed the
institution’s unimpaired capital and unimpaired surplus.  Loans to
directors, executive officers and principal stockholders, and their respective
affiliates, in excess of the greater of $25,000 or 5% of capital and surplus, or
any loans cumulatively aggregating $500,000 or more, must be approved in advance
by a majority of the board of directors of the bank with any “interested”
director not participating in the voting.  State member banks are
prohibited from paying the overdrafts of any of their executive officers or
directors unless payment is made pursuant to a written, pre-authorized
interest-bearing extension of credit plan that specifies a method of repayment
or transfer of funds from another account at the bank.  In addition,
loans to executive officers may not be made on terms more favorable than those
afforded other borrowers and are restricted as to type, amount and terms of
credit.


21




Enforcement.  The
Commissioner has extensive enforcement authority over Maryland
banks.  Such authority includes the ability to issue cease and desist
orders and civil money penalties and to remove directors or
officers.  The Commissioner may also take possession of a Maryland
bank whose capital is impaired and seek to have a receiver appointed by a
court.




The FRB has primary federal enforcement
responsibility over state banks under its jurisdiction, including the authority
to bring enforcement action against all “institution-related parties,” including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
institution.  Formal enforcement action may range from the issuance of
capital directive or a cease and desist order for the removal of officers and/or
directors, receivership, conservatorship or termination of deposit
insurance.  Civil money penalties cover a wide range of violations and
actions, and range up to $25,000 per day or even up to $1 million per day (in
the most egregious cases).  Criminal penalties for most financial
institution crimes include fines of up to $1 million and imprisonment for up to
30 years.




Regulatory Restructuring
Legislation





In
response to the financial crisis, the United States Treasury prepared a
document, released in June 2009 titled, “FINANCIAL REGULATORY REFORM—A NEW
FOUNDATION: Rebuilding Financial Supervision and Regulation,” that proposed
significant regulatory restructuring of depository institutions. The House of
Representatives and Senate are currently considering, legislation that would
restructure the regulation of depository institutions.  Proposals
range from the merger of the Office of Thrift Supervision, which regulates
federal thrifts, with the Office of the Comptroller of the Currency, which
regulates national banks, to the creation of an independent federal agency that
would assume the regulatory responsibilities of the Office of Thrift
Supervision, FDIC, Office of the Comptroller of the Currency and the
FRB.  Also proposed is the creation of a new federal agency to
administer and enforce consumer and fair lending laws, a function that is now
performed by the depository institution regulators.





Enactment of any of these proposals
would revise the regulatory structure imposed on the Bank, which could result in
more stringent regulation.  At this time, management has no way of
predicting the contents or impacts of final legislation.




Personnel




As of December 31, 2009, the Bank had
127 full-time employees and six part-time employees.  The employees
are not represented by a collective bargaining agreement.  The Bank
believes its employee relations are good.


22


Executive
Officers of the Registrant




The executive officers of the Company
are as follows:




Michael L. Middleton (62 years
old) is Chairman, President and Chief Executive Officer of the Company and the
Bank.  Mr. Middleton joined the Bank in 1973 and served in various
management positions until 1979 when he became President of the
Bank.  Mr. Middleton is a Certified Public Accountant and holds a
Masters of Business Administration.  From January 1996 to December
2004, Mr. Middleton served on the Board of Directors of the Federal Home Loan
Bank of Atlanta, serving as Chairman of the Board for 2004.  He also
served as its Board Representative to the Council of Federal Home Loan
Banks.  Mr. Middleton has served on the Board of Directors of the
Federal Reserve Bank, Baltimore Branch, since January 2004.  He also
serves on several philanthropic and civic boards.  He is a trustee for
the College of Southern Maryland and Chairman of the Board of the Energetics
Technology Center.




Effective
March 31, 2010, the Board of Directors of Community Bank of Tri-County named
William J. Pasenelli as President of the Bank to succeed Mr. Middleton. Mr.
Middleton will remain Chairman and CEO of the Bank and continue as Chairman, CEO
and President of Tri-County Financial Corporation.




Gregory C. Cockerham (54 years
old) joined the Bank in November 1988. He serves as the Bank’s Executive Vice
President – Chief Lending Officer. Mr. Cockerham has been in banking for over 30
years.  He is a Paul Harris Fellow with the Rotary Club of Charles
County and serves on various civic boards in Charles County.




William J. Pasenelli (51 years
old) joined the Bank as Chief Financial Officer in April 2000.  Before
joining the Bank, Mr. Pasenelli had been Chief Financial Officer of Acacia
Federal Savings Bank, Annandale, Virginia, since 1987.  Mr. Pasenelli
is a member of the American Institute of Certified Public Accountants, the DC
Institute of Certified Public Accountants, and other civic groups.




Effective
March 31, 2010, the Board of Directors of Community Bank of Tri-County named
William J. Pasenelli as President of the Bank. He will continue to serve as
Chief Financial Officer of both the Bank and Tri-County Financial
Corporation.




James M. Burke (41 years old)
joined the Bank in 2006.  He serves as the Bank’s Executive Vice
President – Chief Credit Officer. Before his appointment as Executive Vice
President in 2007, he served as the Bank’s Senior Credit Officer. Prior to
joining the Bank, Mr. Burke served as Executive Vice President of Mercantile
Southern Maryland Bank. Mr. Burke has almost 20 years of banking experience. Mr.
Burke is Chairman of the Board of Directors of Civista Medical Center and is
active in other civic groups.




James F. DiMisa (50 years old)
joined the Bank in 2006. He serves as Executive Vice President- Chief Operating
Officer.  Prior to joining the Bank, Mr. DiMisa served as Executive
Vice President of Mercantile Southern Maryland Bank. Mr. DiMisa has over 30
years of banking experience. Mr. DiMisa is Chairman of the Board of Trustees for
the Maryland Bankers School and a member of several other civic and professional
groups.


23





Item
1A.   Risk Factors




An investment in shares of our common
stock involves various risks.  Our business, financial condition and
results of operations could be harmed by any of the following risks or by other
risks that have not been identified or that we may believe are immaterial or
unlikely.  The value or market price of our common stock could decline
due to any of these risks, and you may lose all or part of your
investment.  The risks discussed below also include forward-looking
statements, and our actual results may differ substantially from those discussed
in these forward-looking statements.




Our
provision for loan losses increased substantially during the past year and we
may be required to make further increases in our provision for loan losses and
to charge-off additional loans in the future, especially due to our level of
non-performing assets.  Further, our allowance for loan losses may
prove to be insufficient to absorb losses in our loan portfolio.




For 2009,
we recorded a provision for loan losses of $3.5 million.  We also
recorded net loan charge-offs of $1.1 million.  Our non-performing
loans increased significantly in 2009 from $4.9 million, or 0.7% of total
assets, at December 31, 2008 to $19.3 million, or 2.4% of total assets, at
December 31, 2009. The increase was primarily due to the weakened economy and
the softening real estate market.  If the economy and/or the real
estate market continue to weaken, we may be required to add further reserves to
our allowance for loan losses for these assets as the value of the collateral
may be insufficient to pay any remaining net loan balance, which could have a
negative effect on our results of operations.  Like all financial
institutions, we maintain an allowance for loan losses to provide for loans in
our portfolio that may not be repaid in their entirety.  We believe
that our allowance for loan losses is maintained at a level adequate to absorb
probable losses inherent in our loan portfolio as of the corresponding balance
sheet date.  However, our allowance for loan losses may not be
sufficient to cover actual loan losses, and future provisions for loan losses
could materially adversely affect our operating results.





In
evaluating the adequacy of our allowance for loan losses, we consider numerous
quantitative factors, including our historical charge-off experience, growth of
our loan portfolio, changes in the composition of our loan portfolio and the
volume of delinquent and classified loans.  In addition, we use
information about specific borrower situations, including their financial
position and estimated collateral values, to estimate the risk and amount of
loss for those borrowers.  Finally, we also consider many qualitative
factors, including general and economic business conditions, anticipated
duration of the current business cycle, current general market collateral
valuations, trends apparent in any of the factors we take into account and other
matters, which are, by nature, more subjective and fluid.  Our
estimates of the risk of loss and amount of loss on any loan are complicated by
the significant uncertainties surrounding our borrowers’ abilities to
successfully execute their business models through changing economic
environments, competitive challenges and other factors.  Because of
the degree of uncertainty and susceptibility of these factors to change, our
actual losses may vary from our current estimates.




Our
regulators, as an integral part of their examination process, periodically
review our allowance for loan losses and may require us to increase our
allowance for loan losses by recognizing additional provisions for loan losses
charged to expense, or to decrease our allowance for loan losses by recognizing
loan charge-offs.  Any such additional provisions for loan losses or
charge-offs, as required by these regulatory agencies, could have a material
adverse effect on our financial condition and results of
operations.





Certain
interest rate movements may hurt our earnings.





Our
largest component of earnings is net interest income, which could be negatively
affected by changes in interest rates. The Company’s balance sheet is sensitive
to changes in market and competitive interest rates. Changing interest rates
impact customer actions and may limit the options available to the Company to
maximize earnings or increase the costs to minimize risk. We do not have control
over market interest rates and the Company’s focus to mitigate potential
earnings risk centers on controlling the composition of our asset and liability
holdings.





In 2008,
short-term rates fell during the last quarter of the year at an unprecedented
pace. This rapid decline in rates at the end of 2008 decreased yields on certain
types of lending.  This downward pressure on loan yields generally was
not matched by the same level of decline in interest rates paid on funding
sources such as deposits and advances due to market and contractual
conditions.  These rapid changes in interest rates negatively affected
margins in 2008. By the end of the third quarter of 2009, the trend of a
decreasing interest rate spread reversed as decreases in the rates of the
Company’s interest-bearing liabilities decreased at a faster rate than rates of
interest earning assets.




24




In the
future, if interest rates increase rapidly our interest earning deposit
customers may be willing incur penalties to withdraw the funds. The Bank would
either have to acquire deposits at higher rates or risk losing the deposits. If
substantial amounts of interest earning deposits are lost, the Bank would need
to use other available higher costing sources of funds. The increased cost of
the Bank’s financing liabilities may have a negative impact on net interest
income if interest earning assets adjust to current market rates at a slower
rate than liabilities.





Our
increased emphasis on commercial and construction lending may expose us to
increased lending risks.





At December 31, 2009, our loan
portfolio consisted of $293.0 million, or 46.9%, of commercial real estate
loans, $62.5 million, or 10.0%, of construction and land development loans,
$108.7 million, or 17.4%, of commercial business loans and $17.9 million, or
2.9%, of commercial equipment loans.  We intend to maintain our
emphasis on these types of loans.  These types of loans generally
expose a lender to greater risk of non-payment and loss than one- to four-family
residential mortgage loans because repayment of the loans often depends on the
successful operation of the property, the income stream of the borrowers and,
for construction loans, the accuracy of the estimate of the property’s value at
completion of construction and the estimated cost of
construction.  Such loans typically involve larger loan balances to
single borrowers or groups of related borrowers compared to one- to four-family
residential mortgage loans.  Commercial business and equipment loans
expose us to additional risks since they typically are made on the basis of the
borrower’s ability to make repayments from the cash flow of the borrower’s
business and are secured by non-real estate collateral that may depreciate over
time.  In addition, since such loans generally entail greater risk
than one- to four-family residential mortgage loans, we may need to increase our
allowance for loan losses in the future to account for the likely increase in
probable incurred credit losses associated with the growth of such
loans.  Also, many of our commercial and construction borrowers have
more than one loan outstanding with us.  Consequently, an adverse
development with respect to one loan or one credit relationship can expose us to
a significantly greater risk of loss compared to an adverse development with
respect to a one- to four-family residential mortgage loan.





The
recent economic recession could result in increases in our level of
non-performing loans and/or reduce demand for our products and services, which
would lead to lower revenue, higher loan losses and lower earnings.





Our
business activities and earnings are affected by general business conditions in
the United States and in our local market area. These conditions include
short-term and long-term interest rates, inflation, unemployment levels, real
estate values, monetary supply, consumer confidence and spending, fluctuations
in both debt and equity capital markets, and the strength of the economy in the
United States generally and in our market area in particular. The national
economy has recently experienced a recession, with rising unemployment levels,
declines in real estate values and an erosion in consumer confidence. Dramatic
declines in the U.S. housing market over the past few years, with falling home
prices and increasing foreclosures, have negatively affected the credit
performance of mortgage loans and resulted in significant write-downs of asset
values by many financial institutions. Our local economy has mirrored the
overall economy. A prolonged or more severe economic downturn, continued
elevated levels of unemployment, further declines in the values of real estate,
or other events that affect household and/or corporate incomes could impair the
ability of our borrowers to repay their loans in accordance with their terms.
Nearly all of our loans are secured by real estate or made to businesses in
Southern Maryland.  As a result of this concentration, a prolonged or
more severe downturn in the local economy could result in significant increases
in non-performing loans, which would negatively impact our interest income and
result in higher provisions for loan losses, which would hurt our earnings. The
economic downturn could also result in reduced demand for credit, which would
hurt our revenues.




25




The unseasoned nature of our commercial
loan portfolio may result in changes in estimating collectability, which may
lead to additional provisions or charge-offs, which could hurt our
profits.





Our commercial real estate, commercial
business and commercial equipment loans increased $129.7 million, or 44.8%, from
$289.8 million at December 31, 2007 to $419.6 million at December 31,
2009.A large portion of our commercial loan
portfolio is unseasoned and does not provide us with a significant payment
history pattern from which to judge future collectability, especially in this
period ofcontinued
declining and unfavorable economic conditions. As a result, it may be difficult
to predict the future performance of this part of our loan
portfolio.  These loans may have delinquency or charge-off levels
above our historical experience, which could adversely affect our future
performance. Further, these types of loans generally have larger balances and
involve a greater risk than one- to four-family residential mortgage loans.
Accordingly, if we make any errors in judgment in the collectability of our
commercial loans, any resultingcharge-offs may be larger on a per loan
basis than those incurred historically with our residential mortgage loan or
consumer loan portfolios.





Our
inability to retain deposits as they become due may cause us to rely more
heavily on wholesale funding strategies, which could increase our expenses and
adversely affect our operating margins and profitability.





A large
percentage of our certificates of deposit have maturities of less than one year.
The Bank has  marketing and pricing initiatives to retain these
certificates of deposit when they mature, however, there can be no guarantee
that we will retain the deposits necessary to continue to fund asset growth at
reasonable prices.  If we are not able to maintain sufficient
deposits, we will have to rely more heavily on wholesale strategies to fund our
asset growth, which historically are more expensive than retail sources of
funding.  If we are required to rely more heavily on more expensive
funding sources to support future growth, our revenues may not increase
proportionately to cover our costs.  In this case, our operating
margins and profitability would be adversely affected.




Our
continued pace of growth may require us to raise additional capital in the
future, but that capital may not be available when it is needed.




We are
required by regulatory authorities to maintain adequate levels of capital to
support our operations.  We anticipate that we have sufficient capital
resources to satisfy our capital requirements for the foreseeable
future.  We may at some point, however, need to raise additional
capital to support our continued growth.  If we raise capital through
the issuance of additional shares of our common stock or other securities, it
would dilute the ownership interests of existing shareholders and may dilute the
per share book value of our common stock.  New investors may also have
rights, preferences and privileges senior to our current shareholders which may
adversely impact our current shareholders.





Our
ability to raise additional capital, if needed, will depend on conditions in the
capital markets at that time, which are outside of our control, and on our
financial performance.  Accordingly, we may not be able to raise
additional capital, if needed, on terms acceptable to us.  If we
cannot raise additional capital when needed, our ability to further expand our
operations through internal growth could be materially impaired.





Turmoil
in the financial markets could have an adverse effect on our financial position
or results of operations.





Beginning
in 2008, United States and global financial markets experienced severe
disruption and volatility, and general economic conditions have declined
significantly. Adverse developments in credit quality, asset values and revenue
opportunities throughout the financial services industry, as well as general
uncertainty regarding the economic, industry and regulatory environment, have
had a negative impact on the industry. The United States and the governments of
other countries have taken steps to try to stabilize the financial system,
including investing in financial institutions, and have implemented programs
intended to improve general economic conditions. The U.S. Department of the
Treasury created the Capital Purchase Program under the Troubled Asset Relief
Program, pursuant to which the Treasury Department provided additional capital
to participating financial institutions through the purchase of preferred stock
or other securities. Other measures include homeowner relief that encourages
loan restructuring and modification; the establishment of significant liquidity
and credit facilities for financial institutions and investment banks; the
lowering of the federal funds rate; regulatory action against short selling
practices; a temporary guaranty program for money market funds; the
establishment of a commercial paper funding facility to provide back-stop
liquidity to commercial paper issuers; and coordinated international efforts to
address illiquidity and other weaknesses in the banking sector. Notwithstanding
the actions of the United States and other governments, there can be no
assurances that these efforts will be successful in restoring industry, economic
or market conditions to their previous levels and that they will not result in
adverse unintended consequences. Factors that could continue to pressure
financial services companies, including Tri-County Financial Corporation, are
numerous and include (1) worsening credit quality, leading among other
things to increases in loan losses and reserves, (2) continued or worsening
disruption and volatility in financial markets, leading among other things to
continuing reductions in asset values, (3) capital and liquidity concerns
regarding financial institutions generally, (4) limitations resulting from
or imposed in connection with governmental actions intended to stabilize or
provide additional regulation of the financial system, or (5) recessionary
conditions that are deeper or last longer than currently
anticipated.




26




The
limitations on dividends and repurchases imposed through our participation in
the Capital Purchase Program may make our common stock a less attractive
investment.




On
December 19, 2008, the United States Department of the Treasury purchased newly
issued shares of our preferred stock as part of the Troubled Asset Relief
Program’s Capital Purchase Program.  As part of this transaction, we
agreed to not increase the dividend paid on our common stock and to not
repurchase shares of our common stock for a period of three
years.  These capital management devices contribute to the
attractiveness of our common stock and limitations and prohibitions on such
activities may make our common stock less attractive to investors.




The
limitations on executive compensation imposed through our participation in the
Capital Purchase Program may restrict our ability to attract, retain and
motivate key employees, which could adversely affect our
operations.





As part
of our participation in the Capital Purchase Program , we agreed to be bound by
certain executive compensation restrictions, including limitations on severance
payments and the clawback of any bonus and incentive compensation that were
based on materially inaccurate financial statements or any other materially
inaccurate performance metric criteria.  Subsequent to the issuance of
the preferred stock, the President signed the American Recovery and Reinvestment
Act of 2009 into law, which provided more stringent limitations on severance pay
and the payment of bonuses.  To the extent that any of these
compensation restrictions do not permit us to provide a comprehensive
compensation package to our key employees that is competitive in our market
area, we may have difficulty in attracting, retaining and motivating our key
employees, which could have an adverse effect on our results of
operations.





The
terms governing the issuance of the preferred stock to the Treasury may be
changed, the effect of which may have an adverse effect on our
operations.





The terms
of the agreement we entered into with the Treasury provides that the Treasury
may unilaterally amend any provision of the Securities Purchase Agreement to the
extent required to comply with any changes in applicable federal statutes that
may occur in the future.  The American Recovery and Reinvestment Act
of 2009, which placed more stringent limits on executive compensation, including
a prohibition on the payment of bonuses or severance and a requirement that
compensation paid to executives be presented to shareholders for a “non-binding”
vote.  We have no assurances that further changes in the terms of the
transaction will not occur in the future.  Such changes may place
further restrictions on our business or results of operation, which may
adversely affect the market price of our common stock.





Strong
competition within our market area could hurt our profits and slow
growth.





We face intense competition both in
making loans and attracting deposits.  This competition may make it
more difficult for us to originate new loans and may force us to offer higher
deposit rates than currently.  Price competition for loans and
deposits might result in lower interest rates earned on our loans and higher
interest rates paid on our deposits, which would reduce net interest
income.  According to the Federal Deposit Insurance Corporation, as of
June 30, 2009, we held 15.7% of the deposits in Calvert, Charles and St. Mary’s
counties, Maryland, which was the third largest market share of deposits out of
the 14 financial institutions which held deposits in these
counties.  Some of the institutions with which we compete have
substantially greater resources and lending limits than we have and may offer
services that we do not provide.  We expect competition to increase in
the future as a result of legislative, regulatory and technological changes and
the continuing trend of consolidation in the financial services
industry.  Our profitability depends upon our continued ability to
compete successfully in our market area.




27




If
the value of real estate in Southern Maryland were to continue to decline, a
significant portion of our loan portfolio could become under-collateralized,
which could have a material adverse effect on us.





Real estate values in Southern Maryland
have experienced declines over the past two years. A continued decline in local
economic conditions could adversely affect the value of the real estate
collateral securing our loans. A continued decline in property values would
diminish our ability to recover on defaulted loans by selling the real estate
collateral, making it more likely that we would suffer losses on defaulted
loans. Additionally, a decrease in asset quality could require additions to our
allowance for loan losses through increased provisions for loan losses, which
would hurt our profits. Also, a decline in local economic conditions may have a
greater effect on our earnings and capital than on the earnings and capital of
larger financial institutions whose real estate loan portfolios are more
geographically diverse. Real estate values are affected by various factors in
addition to local economic conditions, including, among other things, changes in
general or regional economic conditions, governmental rules or policies and
natural disasters.





Our
business is subject to the success of the local economy in which we
operate.





Because
the majority of our borrowers and depositors are individuals and businesses
located and doing business in Southern Maryland, our success depends, to a
significant extent, upon economic conditions in Southern Maryland. Adverse
economic conditions in our market area could reduce our growth rate, affect the
ability of our customers to repay their loans and generally affect our financial
condition and results of operations.  Conditions such as inflation,
recession, unemployment, high interest rates, short money supply, scarce natural
resources, international disorders, terrorism and other factors beyond our
control may adversely affect our profitability.  We are less able than
a larger institution to spread the risks of unfavorable local economic
conditions across a large number of diversified economies.  Any
sustained period of increased payment delinquencies, foreclosures or losses
caused by adverse market or economic conditions in the State of Maryland could
adversely affect the value of our assets, revenues, results of operations and
financial condition.  Moreover, we cannot give any assurance we will
benefit from any market growth or favorable economic conditions in our primary
market areas if they do occur.




The
trading history of our common stock is characterized by low trading
volume.  Our common stock may be subject to sudden
decreases.




Although our common stock trades on OTC
Electronic Bulletin Board, it has not been regularly traded.  We
cannot predict the extent to which investor interest in us will lead to a more
active trading market in our common stock or how liquid that market might
become.  A public trading market having the desired characteristics of
depth, liquidity and orderliness depends upon the presence in the marketplace of
willing buyers and sellers of our common stock at any given time, which presence
is dependent upon the individual decisions of investors, over which we have no
control.




The market price of our common stock
may be highly volatile and subject to wide fluctuations in response to numerous
factors, including, but not limited to, the factors discussed in other risk
factors and the following:




Ø
            actual
      or anticipated fluctuations in our operating
  results;




Ø
            changes
      in interest rates;




Ø
            changes
      in the legal or regulatory environment in which we
  operate;




Ø
            press
      releases, announcements or publicity relating to us or our competitors or
      relating to trends in our industry;




Ø
            changes
      in expectations as to our future financial performance, including
      financial estimates or recommendations by securities analysts and
      investors;




Ø
            future
      sales of our common stock;




Ø
            changes
      in economic conditions in our marketplace, general conditions in the U.S.
      economy, financial markets or the banking industry;
  and




28




Ø
            other
      developments affecting our competitors or
us.




These
factors may adversely affect the trading price of our common stock, regardless
of our actual operating performance, and could prevent you from selling your
common stock at or above the price you desire.  In addition, the stock
markets, from time to time, experience extreme price and volume fluctuations
that may be unrelated or disproportionate to the operating performance of
companies.  These broad fluctuations may adversely affect the market
price of our common stock, regardless of our trading performance.




We
operate in a highly regulated environment and we may be adversely affected by
changes in laws and regulations.




Community Bank of Tri-County is subject
to extensive regulation, supervision and examination by the Commissioner of
Financial Regulation of the State of Maryland, its chartering authority, the
Federal Reserve Board, as its federal regulator, and by the Federal Deposit
Insurance Corporation, as insurer of its deposits.  Tri-County
Financial Corporation is subject to regulation and supervision by the Federal
Reserve Board.  Such regulation and supervision govern the activities
in which an institution and its holding company may engage and are intended
primarily for the protection of the insurance fund and for the depositors and
borrowers of Community Bank of Tri-County.  The regulation and
supervision by the Commissioner of Financial Regulation of the State of
Maryland, the Federal Reserve Board and the Federal Deposit Insurance
Corporation are not intended to protect the interests of investors in Tri-County
Financial Corporation common stock.  Regulatory authorities have
extensive discretion in their supervisory and enforcement activities, including
the imposition of restrictions on our operations, the classification of our
assets and determination of the level of our allowance for loan
losses.  Any change in such regulation and oversight, whether in the
form of regulatory policy, regulations, legislation or supervisory action, may
have a material impact on our operations.




Provisions
of our articles of incorporation, bylaws and Maryland law, as well as state and
federal banking regulations, could delay or prevent a takeover of us by a third
party.




Provisions
in our articles of incorporation and bylaws and the corporate law of the State
of Maryland could delay, defer or prevent a third party from acquiring us,
despite the possible benefit to our stockholders, or otherwise adversely affect
the price of our common stock.  These provisions include:
supermajority voting requirements for certain business combinations; the
election of directors to staggered terms of three years; and advance notice
requirements for nominations for election to our board of directors and for
proposing matters that shareholders may act on at shareholder
meetings.  In addition, we are subject to Maryland laws, including one
that prohibits us from engaging in a business combination with any interested
shareholder for a period of five years from the date the person became an
interested shareholder unless certain conditions are met.  These
provisions may discourage potential takeover attempts, discourage bids for our
common stock at a premium over market price or adversely affect the market price
of, and the voting and other rights of the holders of, our common
stock.  These provisions could also discourage proxy contests and make
it more difficult for you and other shareholders to elect directors other than
the candidates nominated by our Board.




Proposed
regulatory reform may have a material impact on our operations.





The
United States Treasury prepared a document, released in June 2009 titled,
“FINANCIAL REGULATORY REFORM—A NEW FOUNDATION: Rebuilding Financial Supervision
and Regulation,” that proposed significant regulatory restructuring of
depository institutions. . The U.S. House of Representatives has passed
financial regulatory reform legislation and the Senate is considering its own
version.  The Administration has also proposed the creation of a new
federal agency, the Consumer Financial Protection Agency that would be dedicated
to protecting consumers in the financial products and services
market.  The creation of this agency could result in new regulatory
requirements and raise the cost of regulatory compliance.  In
addition, legislation stemming from the reform plan could require changes in
regulatory capital requirements, loan loss provisioning practices, and
compensation practices.  If implemented, the foregoing regulatory
reforms may have a material impact on our operations. However, because the final
legislation may differ significantly from the reform plan proposed by the
President or passed by the House of Representatives, we cannot determine the
specific impact of regulatory reform at this time.




29




Item
1B.   Unresolved Staff Comments




Not
applicable.




Item 2.  
Properties




The
following table sets forth the location of the Bank’s offices, as well as
certain additional information relating to these offices as of December 31,
2009.




Office
                              Location
                            
                            Year Facility
                              Commenced
                              Operation
                            
                            Leased
                              Or
                              Owned
                            
                            Date of
                              Lease
                              Expiration
                            
                            Approximate
                              Square
                              FootageMain
      Office:3035
      Leonardtown Road
                              Waldorf,
      Maryland
                            
                            1974
                            
                            Owned
                            
                            –
                            
                            16,500Branch
      Offices:22730
      Three Notch Road
                              Lexington
      Park, Maryland
                            
                            1992
                            
                            Owned
                            
                            –
                            
                            2,50025395
      Point Lookout Road
                              Leonardtown,
      Maryland
                            
                            1961
                            
                            Owned
                            
                            –
                            
                            13,000101
      Drury Drive
                              La
      Plata, Maryland
                            
                            2001
                            
                            Owned
                            
                            –
                            
                            2,64510321
      Southern Maryland Boulevard
                              Dunkirk,
      Maryland
                            
                            1991
                            
                            Leased
                            
                            2020
                            
                            2,5008010
      Matthews Road
                              Bryans
      Road, Maryland
                            
                            1996
                            
                            Owned
                            
                            –
                            
                            2,50020
      St. Patrick’s Drive
                              Waldorf,
      Maryland
                            
                            1998
                            
                            Leased
      (Land)
                              Owned (Building)
                            
                            –
                            
                            2,84030165
      Three Notch Road
                              Charlotte
      Hall, Maryland
                            
                            2001
                            
                            Leased
      (Land)
                              Owned
      (Building)
                            
                            2026
                            
                            2,800200
      Market Square
                              Prince
      Frederick, Maryland
                            
                            2005
                            
                            Leased
      (Land)
                              Owned
      (Building)
                            
                            2028
                            
                            2,80011725
      Rousby Hall Road
                              Lusby,
      Maryland
                            
                            2008
                            
                            Leased(Land)
                              Owned
      (Building)
                            
                            2028
                            
                            2,800





Item 3.  Legal
Proceedings





Neither
the Company, the Bank, nor any subsidiary is engaged in any legal proceedings of
a material nature at the present time.  From time to time, the Bank is
a party to legal proceedings in the ordinary course of business.





Item
4.  [Reserved]




30




PART
II





Item 5.  Market
for Registrant’s Common Equity, Related Security Holder Matters and Issuer
Purchases of Equity Securities





Market
Price and Dividends on Registrant’s and Related Stockholder
Matters.





The
information contained under the section captioned “Market for the Registrant’s
Common Stock and Related Security Holder Matters” in the Company’s Annual Report
to Stockholders for the fiscal year ended December 31, 2009 (the “Annual
Report”) filed as Exhibit 13 hereto is incorporated herein by
reference.





Stock
Performance Graph.





Not
required as the Company is a smaller reporting company.





Recent
Sales of Unregistered Securities.





On
December 17, 2007, the Company issued 18,884 shares of its common stock, par
value $0.01 per share, a price of in a private placement exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended and
Rule 506 of Regulation D of the rules and regulations promulgated
thereunder.  An underwriter was not utilized in the
transactions.  The Company received an aggregate of $495,705 in cash
for the shares that were issued.  There were no underwriting discounts
or commissions.  The net proceeds from the offering were distributed
to the Bank to support its growth.





On November 30, 2007, the Company
issued 249,371 shares of its common stock, par value $0.01 per share, a price of
in a private placement exempt from registration under Section 4(2) of the
Securities Act of 1933, as amended and Rule 506 of Regulation D of the rules and
regulations promulgated thereunder.  An underwriter was not utilized
in the transactions.  The Company received an aggregate of $6,545,989
in cash for the shares that were issued.  There were no underwriting
discounts or commissions.  The net proceeds from the offering were
distributed to the Bank to support its growth.





Purchases
of Equity Securities by the Issuer.





The
Company did not repurchase any shares of common stock for the year ended
December 31, 2009.  On September 25, 2008, Tri-County Financial
Corporation announced a repurchase program under which it would repurchase up to
5% of its outstanding common stock or approximately 147,435 shares. However, as
part of the Company’s participation in the Capital Repurchase Program of the
U.S. Department of Treasury’s Troubled Asset Repurchase Program, prior to the
earlier of (a) December 19, 2018 or (b) the date on which the Series A preferred
stock and the Series B preferred stock has been redeemed in full or the Treasury
has transferred all of the Series A preferred stock and the Series B preferred
stock to non-affiliates, the Company, without the consent of the Treasury,
cannot repurchase any shares of its common stock or other capital stock or
equity securities or trust preferred securities. These repurchase restrictions
do not apply in certain limited circumstances, including the repurchase of
common stock in connection with the administration of any employee benefit plan
in the ordinary course of business and consistent with past practice. In
addition, during the period beginning on December 19, 2018 and ending on the
date on which the Series A preferred stock and the Series B preferred stock have
been redeemed in full or the Treasury has transferred all of the Series A
preferred stock and the Series B preferred stock to non-affiliates, the Company
cannot repurchase any shares of its common stock or other capital stock or
equity securities or trust preferred securities  without the consent
of the Treasury.




Item 6.  Selected
Financial Data





The
information contained under the section captioned “Selected Financial Data” of
the Annual Report filed as Exhibit 13 hereto is incorporated herein by
reference.




31




Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operation




The
information contained in the section captioned “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” of the Annual
Report filed as Exhibit 13 hereto is incorporated herein by
reference.




Item
7A.  Quantitative and Qualitative Disclosure About Market
Risk




Not
applicable as the Company is a smaller reporting company.




Item 8.  Financial
Statements and Supplementary Data




The
Consolidated Financial Statements, Notes to Consolidated Financial Statements
and Report of Independent Registered Public Accounting Firm included in the
Annual Report filed as Exhibit 13 hereto are incorporated herein by
reference.




Item 9.  Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure




None.




Item
9A(T).  Controls and Procedures




(a)
            Disclosure
      Controls and Procedures





The
Company’s management, including the Company’s principal executive officer and
principal financial officer, have evaluated the effectiveness of the Company’s
“disclosure controls and procedures,” as such term is defined in Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”).  Based upon their evaluation, the principal executive
officer and principal financial officer concluded that, as of the end of the
period covered by this report, the Company’s disclosure controls and procedures
were effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required
disclosure.





(b)
            Internal
      Controls Over Financial Reporting





Management’s
      annual report on internal control over financial reporting is incorporated
      herein by reference to the Company’s audited Consolidated Financial
      Statements in this Annual Report on Form
10-K.





This
      annual report does not include an attestation report of the Company’s
      registered public accounting firm regarding internal control over
      financial reporting.  Management’s report was not subject to
      attestation by the Company’s registered public accounting firm pursuant to
      temporary rules of the Securities and Exchange Commission that permit the
      Company to provide only management’s report in this annual
      report.





(c)
            Changes
      to Internal Control Over Financial
Reporting





Except as
indicated herein, there were no changes in the Company’s internal control over
financial reporting during the three months ended December 31, 2009 that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.




32




Item
9B.   Other Information




Not applicable.




PART
III




Item
10.  Directors, Executive Officersand Corporate
Governance




For
information concerning the Company’s directors, the information contained under
the section captioned “Items
to be voted on by Stockholders Item  1 — Election of Directors” in
the Company’s definitive proxy statement for the Company’s 2010 Annual Meeting
of Stockholders (the “Proxy Statement”) is incorporated herein by
reference.  For information concerning the executive officers of the
Company, see “Item 1 –
Business – Executive Officers of the Registrant” under Part I of this
Annual Report on Form 10-K.




For
information regarding compliance with Section 16(a) of the Exchange Act, the
cover page of this Annual Report on Form 10-K and the information contained
under the section captioned“Other Information Relating to Directors and Executive Officers Section 16(a)
Beneficial Ownership Reporting Compliance” in the Proxy Statement are
incorporated herein by reference.




For
information concerning the Company’s code of ethics, the information contained
under the section captioned “Corporate Governance – Code of
Ethics” in the Proxy Statement is incorporated by reference.  A
copy of the code of ethics and business conduct is filed as Exhibit 14
hereto.





For information regarding the audit
committee and its composition and the audit committee financial expert, the
section captioned“Corporate
Governance – Committees of the Board of Directors – Audit Committee” in
the Proxy Statement is incorporated by reference.





Item
11.  Executive Compensation




For
information regarding executive compensation, the information contained under
the sections captioned “Executive Compensation” and
“Directors’
Compensation” in the Proxy Statement is incorporated herein by
reference.




33




Item 12.  Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters




(a)  Security
Ownership of Certain Owners




The
information required by this item is incorporated herein by reference to the
section captioned “Principal
Holders of Voting Securities” in the Proxy Statement.




(b)  Security
Ownership of Management




Information
required by this item is incorporated herein by reference to the section
captioned “Principal Holders
of Voting Securities” in the Proxy Statement.




(c)  Changes
in Control




Management
of the Company knows of no arrangements, including any pledge by any person of
securities of the Company, the operation of which may, at a subsequent date,
result in a change in control of the registrant.




(d) Equity
Compensation Plan Information




The
Company has adopted a variety of compensation plans pursuant to which equity may
be awarded to participants.  In 2005, the 1995 Stock Option and
Incentive Plan and the 1995 Stock Option Plan for Non-Employee Directors
expired. In 2005, the stockholders approved the Tri-County Financial Corporation
2005 Equity Compensation Plan. This plan covers employees and non-employee
directors.  The following table sets forth certain information with
respect to the Company’s Equity Compensation Plans as of December 31,
2009.




Plan Category
                
                (a)
                  Number of securities to be issued
                  upon exercise of outstanding
                  options, warrants, and rights
                
                
                (b)
                  Weighted average exercise
                  price of outstanding options,
                  warrants, and rights
                
                
                (c)
                  Number of securities remaining
                  available for future issuance
                  under equity compensation plans
                  (excluding securities reflected in
                  column (a))Equity
      plans approved by security holders
                
                
                273,480
                
                
                
                $16.57
                
                
                
                133,484Equity
      compensation plans not approved by security holders (1)
                
                
                55,763
                
                
                
                $13.46Total
                
                
                329,243
                
                
                
                $16.04
                
                
                
                133,484





(1)
            Consists
      of the Company’s 1995 Stock Option Plan for Non-Employee Directors, which
      expired in 2005 and which provided grants of non-incentive stock options
      to directors who are not employees of the Company or its
      subsidiaries.  Options were granted at an exercise price equal
      to their fair market value at the date of grant and had a term of ten
      years.  Options are generally exercisable while an optionee
      serves as a director or within one year
  thereafter.




Item 13.  Certain
Relationships, Related Transactionsand Director
Independence




The
information regarding certain relationships and related transactions, the
section captioned “Other
Information Relating to Directors and Executive Officers – Policies and
Procedures for Approval and Related Parties Transactions and Relationships and
Transactions with the Company and the Bank” in the Proxy Statement is
incorporated herein by reference.




For information regarding director
independence, the section captioned“Proposal 1 – Election of
Directors” in the Proxy Statement is incorporated by
reference.




34




Item
14.  Principal Accountant Fees and Services




The
information required by this item is incorporated herein by reference to the
section captioned “Audit
Related Matters – Audit Fees an Pre Approval of Services by the Independent
Registered Public Accounting Firm” in the Proxy Statement.




PART
IV




Item 15.  Exhibits
and Financial Statement Schedules




(a)  List of Documents Filed as
Part of this Report




(1)Financial
Statements.The
following consolidated financial statements and notes related thereto are
incorporated by reference from Item 8 hereof:





Report
      of Independent Registered Public Accounting FirmConsolidated
      Balance Sheets as of December 31, 2009 and 2008Consolidated
      Statements of Income for the Years Ended December 31, 2009 and
      2008Consolidated
      Statements of Changes in Stockholders’ Equity for the Years Ended December
      31, 2009 and 2008Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2009 and
      2008Notes
      to Consolidated Financial Statements





(2)Financial
Statement Schedules.  All
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are omitted because of the absence of
conditions under which they are required or because the required information is
included in the consolidated financial statements and related notes
thereto.




(3)Exhibits.  The following is
a list of exhibits filed as part of this Annual Report on Form 10-K and is also
the Exhibit Index.





Exhibit
                  No
                
                Description
                
                Incorporated by Reference to3.1
                
                Articles
      of Incorporation of Tri-County Financial Corporation
                
                Form
      S-4 (Registration No. 333-31287).3.2
                
                Amended
      and Restated Bylaws of Tri-County Financial Corporation
                
                Form
      10-Q for the quarter ended June 30, 2006 as filed on August 14,
      2006.4.1
                
                Articles
      Supplementary establishing Fixed Rate Cumulative Perpetual Preferred
      Stock, Series A, of Tri-County Financial Corporation
                
                Form
      8-K as filed on December 22, 20084.2
                
                Form
      of stock certificate for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series
                
                Form
      8-K as filed on December 22, 20084.3
                
                Articles
      Supplementary establishing Fixed Rate Cumulative Perpetual Preferred
      Stock, Series B, of Tri-County Financial Corporation
                
                Form
      8-K as filed on December 22, 20084.4
                
                Form
      of stock certificate for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series B
                
                Form
      8-K as filed on December 22, 200810.1*
                
                Tri-County
      Financial Corporation 1995 Stock Option and Incentive Plan, as
      amended
                
                Form
      10-K for the year ended December 31, 2000 as filed on March 30,
      2001.10.2*
                
                Tri-County
      Financial Corporation 1995 Stock Option Plan for Non-Employee Directors,
      as amended
                
                Form
      10-K for the year ended December 31, 2000 as filed on March 30,
      2001.




35




10.3*
                        
                        Employment
      Agreement with Michael L. Middleton
                        
                        Form
      10-Q for the quarter ended September 30, 2006 as filed on November 14,
      2006.10.4*
                        
                        Amended
      and Restated Executive Incentive Compensation Plan
                        
                        Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.5*
                        
                        Retirement
      Plan for Directors
                        
                        Form
      10-K for the year ended December 31, 2006 as filed on March 27,
      2007.10.6*
                        
                        Split
      Dollar Agreements with Michael L. Middleton
                        
                        Form
      10-K for the year ended December 31, 2000 as filed on March 30,
      2001.10.7*
                        
                        Split
      Dollar Agreement with William J. Pasenelli
                        
                        Form
      10-K for the year ended December 31, 2001 as filed on April 1,
      2002.10.8*
                        
                        Salary
      Continuation Agreement with Michael L. Middleton, dated September 6,
      2003
                        
                        Form
      10-K for the year ended December 31, 2003 as filed on March 26,
      2004.10.9*
                        
                        First
      Amendment to the Salary Continuation Agreement, dated September 6, 2003,
      with Michael L. Middleton
                        
                        Form
      10-K for the year ended December 31, 2008 as filed on March 9,
      2009.10.10*
                        
                        Tri-County
      Financial Corporation 2005 Equity Compensation Plan
                        
                        Definitive
      Proxy Statement as filed on April 11, 200510.11*
                        
                        Amendment
      No. 1 to the Tri-County Financial Corporation 2005 Equity Compensation
      Plan
                        
                        Form
      10-Q for the quarter ended September 30, 2007 as filed on November 13,
      2007.10.12*
                        
                        Community
      Bank of Tri-County Executive Deferred Compensation Plan
                        
                        Form
      10-K for the year ended December 31, 2006 as filed on March 27,
      2007.10.13*
                        
                        Amended
      and Restated Employment Agreement by and among Community Bank of
      Tri-County, William J. Pasenelli and Tri-County Financial Corporation, as
      guarantor
                        
                        Form
      10-Q for the quarter ended March 31, 2007 as filed on May 11,
      2007.10.14*
                        
                        Amended
      and Restated Employment Agreement by and among Community Bank of
      Tri-County, Gregory C. Cockerham and Tri-County Financial Corporation, as
      guarantor
                        
                        Form
      10-Q for the quarter ended March 31, 2007 as filed on May 11,
      2007.10.15*
                        
                        Salary
      Continuation Agreement with Gregory C. Cockerham, dated August 21,
      2006
                        
                        Form
      10-Q for the quarter ended September 30, 2006 as filed on November 14,
      2006.10.16*
                        
                        First
      Amendment to the Salary Continuation Agreement, dated August 21, 2006,
      with Gregory C. Cockerham
                        
                        Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.17*
                        
                        Second
      Amendment to the Salary Continuation Agreement, dated August 21, 2006,
      with Gregory C. Cockerham
                        
                        Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.18*
                        
                        Salary
      Continuation Agreement with William J. Pasenelli, dated August 21,
      2006
                        
                        Form
      10-Q for the quarter ended September 30, 2006 as filed on November 14,
      2006.10.19*
                        
                        First
      Amendment to the Salary Continuation Agreement, dated August 21, 2006,
      with William J. Pasenelli
                        
                        Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.20*
                        
                        Second
      Amendment to the Salary Continuation Agreement, dated August 21, 2006,
      with William J. Pasenelli
                        
                        Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.21*
                        
                        Letter
      Agreement and related Securities Purchase Agreement – Standard Terms,
      dated December 19, 2008, between Tri-County Financial Corporation and
      United States Department of the Treasury
                        
                        Form
      8-K as filed on December 22,
2008.




36




10.22*
                    
                    Form
      of Waiver executed by each of Michael L. Middleton, Gregory C. Cockerham
      and William J. Pasenelli
                    
                    Form
      8-K as filed on December 22, 200810.23*
                    
                    Form
      of Letter Agreement between Tri-County Financial Corporation and each of
      Michael L. Middleton, Gregory C. Cockerham and William J.
      Pasenelli
                    
                    Form
      8-K as filed on December 22, 200810.24*
                    
                    Salary
      Continuation Agreement between Gregory C. Cockerham and Community Bank of
      Tri-County, dated September 6, 2003, as amended on December 22,
      2008
                    
                    Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.10.25*
                    
                    Salary
      Continuation Agreement between William J. Pasenelli and Community Bank of
      Tri-County, dated September 6, 2003, as amended on June 11, 2004 and
      December 22, 2008
                    
                    Form
      10-K/A for the year ended December 31, 2008 as filed on April 20,
      2009.13.0
                    
                    Annual
      Report to Stockholders for the year ended December 31,
200914.0
                    
                    Code
      of Ethics
                    
                    Form
      10-K for the year ended December 31, 2005 as filed on March 30,
      2006.21.0
                    
                    List
      of Subsidiaries23.1
                    
                    Consent
      of Stegman & Company31.1
                    
                    Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
                    
                    Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer32.0
                    
                    Section
      1350 Certification of Chief Executive Officer, Chief Financial Officer and
      Chief Accounting Officer99.1
                    
                    Principal
      Executive Officer Certification regarding TARP99.2
                    
                    Principal
      Executive Officer Certification regarding TARP










(*)
            Management
      contract or compensating
arrangement.





(b)
            Exhibits.  The
      exhibits required by Item 601 of Regulation S-K are either filed as part
      of this Annual Report on Form 10-K or incorporated by reference
      herein.




(c)
            Financial
      Statements and Schedules Excluded From Annual Report.  There are
      no other financial statements and financial statement schedules which were
      excluded from this Annual Report pursuant to Rule 14a-3(b)(1) which are
      required to be included herein.




37




SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.




TRI-COUNTY
      FINANCIAL CORPORATIONDate:
      March 5, 2010
                    By:
                    /s/
      Michael
      L. MiddletonMichael
      L. MiddletonPresident
      and Chief Executive Officer(Duly
      Authorized
Representative)





Pursuant
to the requirement of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.





By:
                                          /s/
      Michael
      L. Middleton
                                          
                                          By:
                                          /s/
      William
      J. PasenelliMichael
      L. Middleton
                                          
                                          
                                          William
      J. PasenelliDirector, President and Chief Executive Officer
                                          
                                          
                                          Chief Financial Officer(Principal Executive Officer)
                                          
                                          
                                          (Principal Financial and Accounting Officer)Date:
      March 5, 2010
                                          
                                          Date:
      March 5, 2010By:
                                          /s/
      C.
      Marie Brown
                                          
                                          By:
                                          /s/
      Herbert
      N. Redmond, Jr.C.
      Marie Brown
                                          
                                          
                                          Herbert
      N. Redmond, Jr.Director
                                          
                                          
                                          DirectorDate:
      March 5, 2010
                                          
                                          Date:
      March 5, 2010By:
                                          /s/
      H.
      Beaman Smith
                                          
                                          By:
                                          /s/
      Austin
      J. Slater, Jr.H.
      Beaman Smith
                                          
                                          
                                          Austin
      J. Slater, Jr.Director
                                          
                                          
                                          DirectorDate:
      March 5, 2010
                                          
                                          Date:
      March 5, 2010By:
                                          /s/
      Louis
      P. Jenkins, Jr.
                                          
                                          By:
                                          /s/
      James
      R. ShepherdLouis
      P. Jenkins, Jr.
                                          
                                          
                                          James
      R. ShepherdDirector
                                          
                                          
                                          DirectorDate:
      March 5, 2010
                                          
                                          Date:  March
      5, 2010By:
                                          /s/
      Philip
      T. Goldstein
                                          
                                          By:
                                          /s/
      Joseph
      V. Stone, Jr.Philip
      T. Goldstein
                                          
                                          
                                          Joseph
      V. Stone, Jr.Director
                                          
                                          
                                          DirectorDate:
      March 5, 2010
                                          
                                          Date:  March
      5, 2010